howard simons040607gic jun 1007
DESCRIPTION
The Yen Carry Trade Global Interdependence Centre June 11, 2007 An A rbor R esearch & T rading A ffiliated Company Long-Term Interest Rates - 1900 to 2004 Independent · Objective · Original ——————————————————————————————————————————————————————————————————————— Bianco Research, L.L.CJune 11, 2007 – Emerging markets – G-10 markets – Interest rate spread – Spot rate changes – Total carry Topics To Be Covered 2 IntrTRANSCRIPT
The Yen Carry Trade
Howard L. Simons
Global Interdependence Centre June 11, 2007
Long-Term Interest Rates - 1900 to 2004
Bianco Research L.L.C.An Arbor Research & Trading Affiliated Company
Independent · Objective · Original———————————————————————————————————————————————————————————————————————
Bianco Research, L.L.C June 11, 2007 2
Intr
• Short-term (3-month LIBOR) carry trade and its components:– Interest rate spread– Spot rate changes– Total carry
• The importance of the yen carry trade to:– Emerging markets– G-10 markets
• Reading Bank of Japan policies• The Bank of Japan’s task ahead
Topics To Be Covered
Bianco Research, L.L.C June 11, 2007 3
Universe Examined
• A total of 29 different currencies have three-month LIBOR histories over the post-January 1999 timeframe
ISO Code Country ISO Code Country ISO Code Country
ARS Argentina GBP United Kingdom PHP PhilippinesAUD Australia HKD Hong Kong PLN PolandBRL Brazil IDR Indonesia SEK SwedenCAD Canada INR India SGD SingaporeCHF Switzerland JPY Japan THB ThailandCLP Chile KRW Korea TRY TurkeyCOP Colombia MXN Mexico TWD TaiwanCZK Czech Rep. NOK Norway USD United StatesDKK Denmark NZD New Zealand ZAR South AfricaEUR Eurozone PEN Peru
Bianco Research, L.L.C June 11, 2007 4
• Spread returns for each individual currency are based on borrowing at the three-month LIBOR rate of the lower-yielding currency (LY3) and lending at the three-month LIBOR rate of the higher-yielding currency (HY3)
• The net carry return is the difference between the long return (top) and the short return (bottom)
1*
2601Re
1
3
t
tt LYS
LYSHYturnLong t
260Re 3t
LYturnShort t
Constructing The Carry
Bianco Research, L.L.C June 11, 2007 5
• Even when presented on a semilogarithmic scale, short-term JPY rates are an outlier– CHF LIBOR has averaged 12.29 times JPY LIBOR since the January 1999 introduction of the EUR
• Two currencies, the TRY and ARS stand out on the opposite end for having unusually high short-term rates
• Several G-10 countries with high-yielding currencies (NZD, AUD and GBP) have unexpectedly low σ. The opposite is true for several Asian currencies (TWD and KRW)
– One possibility here is the G-10 central banks have adopted greater transparency and hence provide fewer surprises to the markets
Three-Month Interest Rate Returns On Selected CurrenciesJanuary 1999 Onwards
0.000%
0.001%
0.010%
0.100%
1.000%
TRY
AR
SB
RL
IDR
MX
NC
OP
ZAR
PH
PP
LN INR
PE
NN
ZDC
LPA
UD
GB
PN
OK
KR
WTH
BC
AD
CZK
US
DD
KK
HK
DS
EK
EU
RTW
DS
GD
CH
FJP
Y
Ave
rage
Dai
ly R
etur
n (R
osea
te C
olum
ns)
0.000%
0.001%
0.010%
0.100%
1.000%
Stan
dard
Dev
iatio
n O
f Dai
ly R
etur
n (B
lue
Line
)Average IR Return(Left Scale)
Standard Deviation IR Return(Right Scale)
Short-Term Interest Rates And Their Variance
Bianco Research, L.L.C June 11, 2007 6
Correlation Matrix Of IR Spread Returns
• While we might feel safe in concluding IR spreads are correlated positively (blue font, green cells)
• While generally true for 25 of the 29 currencies examined, it is not true for the BRL, ARS, AUD and NZD. These exhibit large swaths of negative correlation (red font, yellow cells)– All four of these currencies have had to maintain high and contra-
cyclical interest rates
Bianco Research, L.L.C June 11, 2007 7
• Let’s look at the total return of borrowing in the JPY and lending elsewhere– The TRY and ARS still stand out as having the highest total returns– The AUD and ZAR, two currencies with heavy commodity linkage, have exceptional σ
in their returns• Several currencies switched rank
– The PLN moved higher– The COP moved lower
Yen Carry Risk And Return
Risk And Return In Three-Month Carry Against JPY Since January 1999
0.01%
0.10%
TRY
AR
S
PLN ID
RM
XN
AU
DN
ZD
BR
LC
ZK
KR
W
INR
PE
N
PH
PZA
R
NO
KC
AD
CO
P
GB
PTH
B
SE
KD
KK
EU
RC
LP
US
D
HK
DS
GD
CH
FTW
D
Ave
rage
Dai
ly R
etur
n Vs
. JPY
(Ros
eate
Col
umns
)
0.5%
0.6%
0.7%
0.8%
0.9%
1.0%
1.1%
1.2%
1.3%
1.4%
1.5%
Stan
dard
Dev
iatio
n of
Dai
ly R
etur
ns (B
lue
Line
)
Average JPY Carry Return(Left Scale)
Standard Deviation JPY Carry Return(Right Scale)
Bianco Research, L.L.C June 11, 2007 8
Decomposing The Yen Carry Trade
• We can break the total return (blue line) into interest rate spread (green column) and spot rate (red column) components
• The TRY and ARS both had interest rate gains high enough to offset spot rate losses
• The BRL’s rate gains were insufficient to prevent it from sliding lower in rank
• The PLN’s spot rate component was positive, accounting for the aforementioned shift higher. The COP’s was a robber, though
Analyzing The Yen Carry Trade Since January 1999
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
TRY
AR
SP
LN IDR
MX
NB
RL
NZD
AU
DC
ZKK
RW
INR
PE
NP
HP
ZAR
NO
KC
AD
CO
PG
BP
THB
SE
KD
KK
EU
RC
LPU
SD
HK
DS
GD
CH
FTW
D
Dec
ompo
sitio
n of
Ave
rage
Ann
ual R
etur
n O
nYe
n C
arry
Tra
de
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
Ave
rage
Ann
ual T
otal
Ret
urn
On
Yen
Car
ry T
radeRate
Spot
Total
Bianco Research, L.L.C June 11, 2007 9
• If we map average annual stock market returns in USD terms against the average annual total return on the yen carry trade, we find a strong positive relationship (β=1.54) between equities and the yen carry once Turkey & Argentina are excluded
• If the total return on the yen carry trade is dependent more on interest rate spreads than on spot rate returns, we would have to conclude capital inflows outweigh the negative effects of higher interest rates
The Yen Carry Trade And Equity Markets
Positive Correlation Between Yen Carry And Equities
0.0%
2.5%
5.0%
7.5%
10.0%
12.5%
15.0%
17.5%
20.0%
22.5%
25.0%
27.5%
30.0%
0.0%
2.5%
5.0%
7.5%
10.0
%
12.5
%
15.0
%
17.5
%
20.0
%
22.5
%
25.0
%
Average Annual Return On Yen Carry Trade
Ave
rage
Ann
ual E
quity
Mar
ket R
etur
n, U
SD
Turkey
Argentina
Bianco Research, L.L.C June 11, 2007 10
Decomposing Equity Market Relationship
• If we exclude Turkey & Argentina from the analysis, we can see the strong positive relationship (β=1.08) between the interest rate spread component of the carry trade and equity returns (top chart)
• The relationship between the spot rate component and equity returns (bottom chart) is near-random (β= -.085)
• Restated, equity markets in high-interest rate spreads benefit directly from the capital inflows engendered by the carry trade. An increase in JPY LIBOR or a narrowing of the spread poses a threat to these markets
Positive Correlation Between Rate Component of Yen Carry And Equities
0%
3%
5%
8%
10%
13%
15%
18%
20%
23%
25%
28%
30%
0% 5% 10%
15%
20%
25%
30%
35%
40%
45%
Average Annual Return On Interest Rate Spread Component Of Yen Carry Trade
Ave
rage
Ann
ual E
quity
Mar
ket R
etur
n, U
SD
Turkey
Argentina
No Correlation Between Spot Component of Yen Carry And Equities
0%
5%
10%
15%
20%
25%
30%
-20.
0%
-17.
5%
-15.
0%
-12.
5%
-10.
0%
-7.5
%
-5.0
%
-2.5
%
0.0%
2.5%
5.0%
7.5%
Average Annual Return On Spot Rate Component Of Yen Carry Trade
Ave
rage
Ann
ual E
quity
Mar
ket R
etur
n, U
SD
Turkey
Argentina
Bianco Research, L.L.C June 11, 2007 11
• The Bank of Japan’s two moves to raise rates in 2006 and 2007 (green lines) had an immediate and visible impact on emerging market equities
• The BOJ moved to restore funds in its current account balance in June 2006 and assured the world no further rate increases would be coming in short order in 2007
• Is there a “BOJ put” in global markets if their moves to raise rates become disruptive? And, if so, is this really a bad thing?
Emerging Market Equity Impact
Short-Term Yen Rates Matter
0.01%
0.10%
1.00%
Apr
-04
Jun-
04
Jul-0
4
Sep
-04
Nov
-04
Jan-
05
Mar
-05
May
-05
Jul-0
5
Sep
-05
Nov
-05
Jan-
06
Mar
-06
May
-06
Jul-0
6
Sep
-06
Oct
-06
Dec
-06
Feb-
07
Apr
-07
Thre
e-M
onth
JPY
LIB
OR
(Thi
n R
ed L
ine)
400
450
500
550
600
650
700
750
800
850
900
950
MSC
I Em
ergi
ng M
arke
ts F
ree
Inde
x (B
lue
Line
)
Three-Month JPY(Left Scale)
MSCI Emerging Markets(Right Scale)
Bianco Research, L.L.C June 11, 2007 12
• The JPY/EUR cross-rate began to diverge after the Bank of Japan ended quantitative easing in May 2006
• While Europeans have been noisy regarding the JPY/EUR, the JPY/CNY cross is far more important to Japan’s global position
– In a mercantilist culture within a mercantilist region, the concept of competitive devaluation is accepted
– Just as in French, there is no word for laissez faire
Comparative Currency Strength After Yuan Peg Loosened
102.0%
102.5%
103.0%
103.5%
104.0%
104.5%
105.0%
105.5%
106.0%
106.5%
107.0%
107.5%
Jul-0
5A
ug-0
5S
ep-0
5S
ep-0
5O
ct-0
5N
ov-0
5N
ov-0
5D
ec-0
5Ja
n-06
Jan-
06Fe
b-06
Mar
-06
Mar
-06
Apr
-06
May
-06
Jun-
06Ju
n-06
Jul-0
6A
ug-0
6A
ug-0
6S
ep-0
6O
ct-0
6O
ct-0
6N
ov-0
6D
ec-0
6D
ec-0
6Ja
n-07
Feb-
07M
ar-0
7M
ar-0
7A
pr-0
7
Chi
nese
Yua
n, J
uly
20, 2
005
= 10
0%(T
hin
Red
Lin
e)
92%
94%
96%
98%
100%
102%
104%
106%
108%
110%
112%
Yen
and E
uro,
July
20,
200
5 =
100%
(Thi
ck B
lue
And
Hat
ched
Gre
en Li
nes)
Yuan Index(Left Scale)
Euro Index(Right Scale)
Yen Index(Right Scale)
The Yen’s Post-Yuan Peg Divergence
Bianco Research, L.L.C June 11, 2007 13
• The yen carry, as measured by the forward rate ratio between JPY LIBOR and ten-year UST, reached its apex equilibrium in late 1995– Ten-year UST rates continued their secular decline– Modest flattenings (arrows) in mid-1998 and late 2000 preceded global equity market
downturns, but had no negative impact on ten-year rates• The multi-generational low in ten-year UST (green line) occurred three years
before the carry started to decline
The Yen Carry And Long-Term Treasury Rates: Long View
Did The Carry Trade Matter In The Long-Term?
3.00%
3.50%
4.00%
4.50%
5.00%
5.50%
6.00%
6.50%
7.00%
7.50%
8.00%
8.50%
9.00%
9.50%
Nov
-89
May
-90
Nov
-90
May
-91
Nov
-91
May
-92
Oct
-92
Apr
-93
Oct
-93
Apr
-94
Oct
-94
Apr
-95
Oct
-95
Apr
-96
Oct
-96
Apr
-97
Oct
-97
Apr
-98
Oct
-98
Apr
-99
Oct
-99
Apr
-00
Oct
-00
Apr
-01
Oct
-01
Apr
-02
Oct
-02
Apr
-03
Oct
-03
Apr
-04
Oct
-04
Apr
-05
Oct
-05
Apr
-06
Oct
-06
Apr
-07
U.S
. Ten
-Yea
r Not
es (T
hin
Red
Lin
e)
0.9975
1.0000
1.0025
1.0050
1.0075
1.0100
1.0125
1.0150
1.0175
1.0200
1.0225
1.0250
1.0275
JPY
3-M
o - U
SD 1
0-Yr
FR
R (T
hick
Blu
e Li
ne)USD 10-Year Notes
(Left Scale)
JPY 3-Mo - USD 10-Yr FRR(Right Scale)
Bianco Research, L.L.C June 11, 2007 14
• If we confine our view to the period after the CNY began to revalue, we see a complete lack of connection between the yen carry and ten-year UST yields
– Prior to May 2006, UST rates rose in a wide carry– Between May 2006 and February 2007, UST rates fell and rose parallel to a
flattening and widening yen carry– After February 2007, UST rates rose and that kept the carry positive
The Yen Carry And Long-Term Treasury Rates: Short View
Rising U.S. Note Yields Keeping Yen Carry Positive
4.000%
4.125%
4.250%
4.375%
4.500%
4.625%
4.750%
4.875%
5.000%
5.125%
5.250%
Jul-0
5
Aug
-05
Sep
-05
Oct
-05
Nov
-05
Dec
-05
Jan-
06
Feb-
06
Mar
-06
Apr
-06
May
-06
Jun-
06
Jul-0
6
Aug
-06
Sep
-06
Oct
-06
Nov
-06
Dec
-06
Jan-
07
Jan-
07
Mar
-07
Mar
-07
U.S
. Ten
-Yea
r Not
es (T
hin
Red
Lin
e)
1.02175
1.02200
1.02225
1.02250
1.02275
1.02300
1.02325
1.02350
1.02375
1.02400
1.02425
1.02450
1.02475
1.02500
1.02525
1.02550
1.02575
1.02600
JPY
3-M
o - U
SD 1
0-Yr
FR
R (T
hick
Blu
e Li
ne)
USD 10-Year Notes(Left Scale)
JPY 3-Mo - USD 10-Yr FRR(Right Scale)
Bianco Research, L.L.C June 11, 2007 15
Forward Yen Demand
• Yen borrowed in a carry trade have to be repaid
– The drop in the yen carry to ten-year UST after May 2006 had no significant effect on yen volatility (top chart)
– If there was a panic to unwind the yen carry trade and sell long-term UST in the process, it was invisible in the data
• Yen volatility has tracked the yen itself closely since the May 2006 withdrawal of liquidity by the Bank of Japan
Reduced Carry Leads To Reduced Demand For Yen
1.0210
1.0215
1.0220
1.0225
1.0230
1.0235
1.0240
1.0245
1.0250
1.0255
1.0260
1.0265
Jan-
99A
pr-9
9Ju
l-99
Oct
-99
Dec
-99
Mar
-00
Jun-
00S
ep-0
0D
ec-0
0M
ar-0
1Ju
n-01
Sep
-01
Dec
-01
Mar
-02
Jun-
02S
ep-0
2D
ec-0
2M
ar-0
3Ju
n-03
Sep
-03
Dec
-03
Mar
-04
Jun-
04S
ep-0
4D
ec-0
4M
ar-0
5Ju
n-05
Sep
-05
Dec
-05
Mar
-06
Jun-
06S
ep-0
6D
ec-0
6M
ar-0
7
FRR
, 3-M
o. J
PY to
10-
Yr. U
SD (T
hin
Red
Lin
e)
6%
8%
10%
12%
14%
16%
18%
20%
Thre
e-M
onth
JPY
Vol
atili
ty (T
hick
Blu
e Li
ne)
JPY 3-Mo - USD 10-Yr FRR(Left Scale)
Yen Volatility(Right Scale)
QuantitativeEasing Ended
Little Fear Of Yen Appreciation
108
110
112
114
116
118
120
122
Jul-0
5A
ug-0
5A
ug-0
5S
ep-0
5O
ct-0
5N
ov-0
5N
ov-0
5D
ec-0
5Ja
n-06
Jan-
06Fe
b-06
Mar
-06
Mar
-06
Apr
-06
May
-06
Jun-
06Ju
n-06
Jul-0
6A
ug-0
6A
ug-0
6S
ep-0
6O
ct-0
6O
ct-0
6N
ov-0
6D
ec-0
6D
ec-0
6Ja
n-07
Feb-
07M
ar-0
7M
ar-0
7A
pr-0
7
JPY
Per U
SD, I
nver
se S
cale
(Thi
n R
ed L
ine)
6.25%
6.75%
7.25%
7.75%
8.25%
8.75%
9.25%
9.75%
10.25%
10.75%
JPY-
USD
3-M
onth
Vol
atili
ty (T
hick
Blu
e Li
ne)
Yen(Left Scale)
Yen Volatility(Right Scale)
Bianco Research, L.L.C June 11, 2007 16
• Over a longer period of time, the volatility on three-month JPY forwards has led changes in the yen by 23 weeks on average
• As the yen carry trade was years in the making, we should expect to see a long-term rise in this volatility lead any immediate change in the yen
Forward Yen Demand: The Longer-Term View
Price Of Insuring Against JPY Appreciation
100
105
110
115
120
125
130
135
Jan-
99A
pr-9
9Ju
l-99
Oct
-99
Jan-
00A
pr-0
0Ju
l-00
Oct
-00
Jan-
01A
pr-0
1Ju
l-01
Oct
-01
Jan-
02A
pr-0
2Ju
l-02
Oct
-02
Jan-
03A
pr-0
3Ju
l-03
Oct
-03
Jan-
04A
pr-0
4Ju
l-04
Oct
-04
Dec
-04
Apr
-05
Jul-0
5S
ep-0
5D
ec-0
5M
ar-0
6Ju
n-06
Sep
-06
Dec
-06
Mar
-07
JPY
Per U
SD (T
hin
Red
Lin
e, In
vers
e Sc
ale)
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
Thre
e-M
onth
JPY
Vol
atili
ty (T
hick
Blu
e Li
ne)
JPY Per USDLed 23 Weeks
(Left Scale)
Three-Month JPY Volatility(Right Scale)
Quantitative Easing Ended
Bianco Research, L.L.C June 11, 2007 17
The BOJ’s Situation
• The world became addicted to cheap yen– When low rates failed to stimulate the Japanese economy, quantitative
easing (green lines) was employed• The first yen carry shock in May 2006 was far more a response to
reduced quantity of yen (red columns) than higher price (blue line)– The BOJ restored ¥10 trillion in June 2006; this ended the first shock
• The second yen carry shock was solely a price affair and ended as soon as the BOJ signaled a lack of hostile intent
Price And Quantity Of Yen
2.5
7.5
12.5
17.5
22.5
27.5
32.5
37.5
Mar
-00
Jun-
00S
ep-0
0D
ec-0
0M
ar-0
1M
ay-0
1A
ug-0
1N
ov-0
1Fe
b-02
May
-02
Aug
-02
Nov
-02
Feb-
03M
ay-0
3A
ug-0
3O
ct-0
3Ja
n-04
Apr
-04
Jul-0
4O
ct-0
4Ja
n-05
Apr
-05
Jul-0
5O
ct-0
5Ja
n-06
Mar
-06
Jun-
06S
ep-0
6D
ec-0
6M
ar-0
7
BO
J C
urre
nt A
ccou
nt B
alan
ce, ¥
Tril
lion
(Ros
eate
Col
umns
)
0.01%
0.10%
1.00%
Thre
e-M
onth
JPY
LIB
OR
(Blu
e Li
ne)
Current Account(Left Scale)
JPY LIBOR(Right Scale)
Bianco Research, L.L.C June 11, 2007 18
• The yen carry trade is very real• A wide range of global equity market returns have a strong positive
beta to the interest rate spread between local currencies and the JPY– Capital inflows outweigh high local interest rates– This is prima facie evidence of yen-dependence
• Surprisingly, the carry to long-term UST is unimportant in the course of U.S. interest rates
• Two different attempts by the Bank of Japan to reduce its impact have contributed to global financial shocks
– Both shocks were ended quickly by the BOJ itself, giving rise to the moral hazard of a “BOJ put” in world markets
• The ease with which both shocks ended is consistent with a negative-sum game reaction by markets to a perceived danger. It is neither the level of the yen carry nor the quantity of yen provided that are important, but rather a sense no one else has an incentive to panic
• The BOJ needs, therefore, to engage in a policy of “deposit insurance,” a public signal it will not engage in injurious policies. Then a restoration of normal interest rates in Japan can proceed
Conclusions
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Arbor Research & Trading (UK) LTD4 Broadgate, 2nd Floor – Room 57London England EC2M 2QYPhone 44-207-965-4784 Fax 44-207-965-4787Neil Tritton [email protected] Ben Gibson [email protected]
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