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.
Whoa, aren't you listening? Owning Property Is Bad! If you're not going to rent forever like a smart investor, at least only go coop.
LOL! By that I mean associates I know in the broker trade. They are moving stuff out of real estate. But they are still screaming, so that is probably a good thing.
That's the spirit! Renting keeps you away from all those lending schemes designed to foreclose on your property (which lenders would rather have empty as we know), since people should not be held responsible for failing to read a contract! Or to actually pay for their loan, which got them a house & land for hundreds of thousands of dollars they don't have!
By the way, as a renter, you can also apply for Sec 8 or DSS so that you can go buy that plasma screen TV you need.
bump
I already have that...
I hit up my relatives, my only section eight was from the US Army (j/k)
Probably by the end of 2007 we'll see short rates in Japan at still less than 2%. Ham on rye. There is a possibility that we'll see much less demand for US debt, gold, mortgages or whatever else the carry trade has been buying up and leveraging. But we won't see panic selling.
Perhaps it has a double meaning for renters mentally unfit to own property....or to be frightened out of using leverage to own the roof over your head, the only investment that provides physical shelter from the elements.
You are talking out of your ass.
Much residential and commercial property is about to become available through foreclosures and bankruptcy. One man's problem is another's opportunity.
Can you please define a "mortgage derivate" for me, and how they effect the balance sheets of Fannie and Freddie?
BTW, I am a former mortge derivate trader.
"Legit Mortgage rates aren't tied to the Fed rate."
You're right, they're not "tied to" the Fed rate. 10 year treasuries have served as more of a benchmark. Increasingly, the newly reintroduced 30 year will begin to serve that purpose. However, the Fed rate does have an impact on treasury yields, and therefore mortgage rates, indirect though it may be. The big factor, and one that is largely outside of our control, is the fact tha yields are being depressed by heavy buying from China, Japan, etcetera ... dollars coming home to roost, so to speak. So long as this continues, long rates will continue to be lower than some might prefer.
On the other hand, when compared against the catostrophe of the Carter Years, this burp hardley registers.
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