Tuesday, April 03, 2007

Yen Carry Trade Factor

Malaysian market is not isolated anymore. The previous uptrend was due to excess of liquidity. Foreign funds are in and out almost every trading day. So I think we should monitor closely the mother of all liquidity - YEN CARRY TRADE (the movement of USD/YEN, DOW JONES and NIKKEI).

From observation (pls correct me if I'm wrong + some good reasons):

If USD/YEN dwn + Dow Jones dwn + Nikkei dwn = Bad news (KLCI might also turn south)

If USD/YEN dwn + Dow Jones up (vice versa) = no significant effect on Nikkei & KLCI

If USD/YEN up + Dow Jones up + Nikkei up = Good news (yiipie kayea for KLCI).

Neither Shanghai, Hang Seng/STI/KOSPI nor Greenspan leads the KLCI - but the DJ, USD/YEN & Nikkei.

Yen Carry Trade 101

The Bank of Japan’s zero interest rate policy since early 2001 has created an incentive to borrow in Japan at close to nil interest rates and employ the borrowed money to buy high yielding assets such as US 10 year Treasury Notes. For instance, an individual borrows 106,200 Yen from a Japanese bank at 0.5 per cent interest rate, which he then exchanges for US$900 (the exchange rate is 118 yen per US$).

He then uses the $900 borrowed money together with his own $100 to invest in US Treasury Notes for a yield of 4.5 per cent. After one year the $1000 becomes $1045, implying that after interest expenses of $4.5 our investor makes a profit of $40.5, which amounts to 40.5 per cent return on his $100. As long as the dollar stays stable or does not fall against the Yen our investor is going to make a hefty return on his money.

However, the whole thing could reverse very rapidly should the US$ depreciate against the Yen. Let us say that the Yen has appreciated against the US$ and it is trading at the end of the year at 115 Yen per US$. In this case on the maturity date, one-year after, our investor must repay $928 — this means that his profit falls to $17, or 17 per cent. Obviously should the Yen to appreciate much more, let us say to 112 Yen, then his repayment to the Japanese bank in dollar terms will amount to $953 implying a loss of 8 per cent.

So it is not surprising that most Yen carry trade players have become very fearful of the recent appreciation in the Yen against the US$. (On Thursday March 8 the price of US$ in Yen terms fell to below 116 Yen against 118.44 Yen at the end of February). Most analysts maintain that the Yen carry trade has boosted world liquidity and this in turn has given a boost to asset prices in all parts of the world. It is held that as a result of the strengthening in the Yen an unwinding of the Yen carry trade is likely to ensue, which in turn could lead to the decline in the world liquidity. A fall in world liquidity in turn could pose a serious threat to financial markets and to world economic activity, so it is held.

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