Posted on 03/01/2006 10:27:06 AM PST by ex-Texan
The cash machine that sustained a world boom is about to close, and it's going to get ugly, says Ambrose Evans-Pritchard
One by one, the eurozone, the Swedes, the Swiss and now even the Japanese, are turning off the tap of ultra-cheap credit that has flushed the global system for the past year, keeping the ageing asset boom alive.
The "carry trade" - as it is known - is a near limitless cash machine for banks and hedge funds. They can borrow at near zero interest rates in Japan, or 1pc in Switzerland, to re-lend anywhere in the world that offers higher yields, whether Argentine notes or US mortgage securities.
Arguably, it has prolonged asset bubbles everywhere, blunting the efforts of the US and other central banks to restrain over-heating in their own countries.
The Bank of International Settlements last year estimated the turnover in exchange and interest rates derivatives markets at $2,400bn a day.
"The carry trade has pervaded every single instrument imaginable, credit spreads, bond spreads: everything is poisoned," said David Bloom, currency analyst at HSBC.
"It's going to come to an end later this year and it's going to be ugly, even if we haven't reached the shake-out just yet," he said.
"People have a Panglossian belief in the march of global capitalism but that will change as soon as attention switches back to US financial imbalances," he said.
There were early signs of panic this week when the Icelandic krone crashed 8pc in two days, setting off dominoes in high-yielding currencies of New Zealand, Australia, South Africa, Hungary and Brazil.
The debacle was triggered when the rating agency Fitch downgraded Iceland's sovereign debt, a move that would not normally rattle markets.
The new skittishness comes against a backdrop of ever more hawkish moves by Japan and Europe.
"There are several hundred billion dollars of positions in the carry trade that will be unwound as soon as they become unprofitable," said Stephen Lewis, an economist at Monument Securities. "When the Bank of Japan starts tightening we may see some spectacular effects. The world has never been through this before, so there is a high risk of mistakes."
Toshihiko Fukui, the Japanese central bank governor, gave a fresh warning yesterday that this day is near, saying the country was pulling out of seven years of deflation. The economy grew at a 5.5pc rate in the fourth quarter of 2005.
In his strongest words yet, he said the bank would act "immediately" to curtail its extra injections of liquidity, preparing the way for rate rises above zero in coming months.
"The moment of truth is approaching,'' said Kenichiro Ikezawa of Daiwa SB. In Europe, Sweden raised rates to 2pc this week in the face of an overheated Stockholm property market, while Germany's IFO business climate index soared yesterday to its highest level in 14 years.
The European Central Bank will almost certainly raise eurozone rates to 2.5pc in March, with likely moves to 3pc by the end of the year.
Most of the world is now tightening, with no sign of a fresh credit window opening to keep the game going. This is new. Japan has had the tap on continuously as the trade exploded over the past five years, while America itself became the source of funds after it slashed rates to 1pc at the end of the dotcom bubble, and held them there until June 2004.
The US Federal Reserve has since raised rates 14 times to 4.5pc in a belated effort to restore monetary discipline, with at least two more rises priced into the markets.
It is an open question whether the yen, euro, Swiss franc and Swedish krona carry trades have occurred on such a scale that they have led to over-investment in Latin America and beyond, and compressed US yields, fuelling the American housing boom in 2005 despite Fed tightening.
There are other big forces at work: huge purchases of US Treasuries by Asian central banks, and petrodollar surpluses coming back to the US credit markets. Stephen Roach, chief economist at Morgan Stanley, warns that the carry trade is itself, in all its forms, a major cause of dangerous speculative excess. "The lure of the carry trade is so compelling, it creates artificial demand for 'carryable' assets that has the potential to turn normal asset price appreciation into bubble-like proportions," he said.
"History tells us that carry trades end when central bank tightening cycles begin," he said. Ominously, almost every bank other than the Bank of England is now tightening in unison.
The spigot might be turned off, but there is still plenty of gurgling at this end of the pipeline. Still get an offer a day of enough credit to put one into lifetime slavery.
Thanks for the tip. Do you always refer to UAE publications for your business news?
Incidently, conspiracy theories notwithstanding, the Japanese don't suddenly decide to "turn off the tap on ultra cheap credit." Their own credit markets offer a lower rate of return than ours, because they are suffering from deflation. That's why they buy our bonds. Which, in turn, drives the interest rate the US TReasury must offer lower. This is covered in the first week of any HS AP Economics course.
This is actually from the UK Telegraph, but in any case, the UAE is our good friend and strategic ally. What's your problem?
([T]he Swedes)???????... HuH?
This author leaves out the major player, next to Uncle Sugar, his homeland!?
Maybe humans can indeed control the weather. Might be easier than trying to control this market, tho'...
ping for later
No, the article was picked up by the Telegraph in association with Emirates UK. Don't believe me? Click on the link. And, to be honest with you, I have no problem with the UAE or the ports deal. I just don't see the need to be referring to them for evaluations of the world economy. But that's neither here nor there. This is a poorly written piece. Credit markets do not suddenly reverse themselves.
[oh, sorry, that was Dallas in 1982 - it was sheer terror back then - people screeming in the streets]
I think the answer is to keep renting. That's the best way to build wealth over the long run. Owning property is a mistake, because the market never goes back up. In fact, some people who bought years ago are in bad straits, their $300,000 equity may go down to $280,000. They should never have bought a house. Idiots.
If you do not understand those facts, please let me explain. It is highly likely that your mortgage was sold by the lender within six months after you signed the papers. Lenders resell mortgages. They are packaged into graded bonds (based on credit review of the borrowers) and sold to buyers on Wall Street. Most of these mortgage bonds have been purchased by wealthy foreigners, hedge funds, rich Arab sheiks, governments, including the UAE.
What this all means is that if you are paying a mortgage today you may be paying wealthy foreigners. How much American credit does the UAE hold? Nobody really knows.
But one thing is certain: Be very careful about making your payments. There are mortgage scams out there. Lenders may be set up to foreclose properties rapidly. Your friendly mortgage company might even be owned by wealthy oil traders from the UAE.
The Bankruptcy Act was amended by Congress last year. People can no longer walk away from their homes when things turn bad. People will pay and pay for years after their homes have been seized. Are you getting the picture yet?
Guys, forget about the UAE connection. It is a distraction for you. Assuming that this column comes from a reputible news course, it is stilly using faulty logic, and an incomplete understanding of global credit markets.
Great Post!...
Get ready with your nomex suit because the "EVER" Bulls will be here to spout thier typicl government statistics and debunk this and maybe you...
Cheers...
Gold to the moon if this unwinds...
With the collapse of the housing market, bird flu and the communist take over of San Fransico, I am damn near ready to reach for another beer which is disheartning, 'cos I don't drink.
If you are going to post yield curves, you might want to identify them. Also, one month is not a useful historical sample for the pruposes of this discussion.
No big deal. Companies are trolling for foreclosures.
I don't drink either, but I might join you, because an asteroid just missed us this summer, hackers are busy creating the latest computer virus, the planet will run out of oil any second now, and TomKat is splitting up.
BTW, I am wearing scuba gear as a type this. NYC will soon be under water due to Global Warming.
This story is suddenly all over various media outlets (search Google news for "carry trade"), and I promise you some well-placed fund managers had their positions carefully set up to benefit from a day or two of market chatter about this.
For the record, Lyndon LaRouche agrees with you that this is about to cause the collapse of the global financial system.
http://www.larouchepub.com/pr_lar/2006/lar_pac/060226carry_trade.html
Real live FX traders, however, are treating it as just another normal trend shift.
http://www.dailyfx.com/story/dailyfx_financial_markets_headlines/dailyfx_financial_markets_headlines/6946_carry_trade_liquidation.html
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