Introducing the New Funding Currency for the Carry Trade

Also In Today’s Letter…

• Introducing the New “Japanese Yen”
• As If We Needed Another Watchdog…
• You Asked: Why Pair the Pound with the Dollar?

Well, here we go with the last three days of September…

It’s been a crazy month, hasn’t it? In just the last month, gold returned to $1,000 and non-dollar currencies all returned to levels they held a year ago.

Ever since Lehman Brothers collapsed, currencies have been fighting the onslaught of flight to “safe” dollar trades. Now that’s finally turning around.

We’ve heard the Fed Chairman sound the “all clear horn.” (Seriously, why is anyone still listening to this guy?!) And our country is becoming quite divided over the health care issue.

So, there we have it, we’re all caught up now.

On Friday, the currencies gravitated toward weaker levels. Dollar buying continued, with stocks leading the risk assets lower. But currencies haven’t been taken to the woodshed just yet. So, the question remains if this is the correction we’ve been waiting for or not.

Meanwhile, the dollar has another gauntlet to jump through in the months to come…

Introducing the New “Japanese Yen”

Not so long ago, traders used to borrow the Japanese yen with its 0% interest rates, and then reinvested that money into British pounds, euros, or Aussie dollars yielding anywhere from 4% to 8%. Then traders pocketed the differenced. It was known as the “carry trade,” and traders used it all over the world.

Of course that was before the global financial crisis. Today there is a new low-yielding currency in town, the dollar. Once again, traders are using the dollar to fund carry trades.

Last week, the Financial Times ran a story about the dollar being the top carry trade currency in the world. Let’s read a bit from the FT…

“For years, the yen was the currency of choice to fund international carry trades. Analysts say negligible U.S. interest rates, its quantitative easing measures and little sing that the country is set to withdraw from its ultra-lose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.”

Let’s talk about that for a minute. If the dollar begins to become the new funding currency of the carry trade, that means that people will be selling the dollar short, and using the proceeds to buy a higher yielding asset.

Well, in today’s markets, you won’t find many traditional “high yielding assets.” You really need high-yielders and an interest rate differential to make carry trades work. That’s because carry trades can be quite risky, so you need to have some cushion from the “buy side” asset to make carry trades worth your time.

The only “real interest differential” in the world resides in Brazil. But the real is traded on a non-deliverable forward, which means it’s just as liquid as say the Aussie or kiwi. That’s very interesting considering the Australian dollar and New Zealand dollars were the main beneficiaries of yen carry trades in the past.

So this new carry trade, might have to wait a bit before getting into 4th gear. When the Reserve Bank of Australia (RBA) begins their rate hike cycle, probably by year-end, then it might begin to make sense. I’ll be keeping my eye on this in the meantime.

Did You Get That Memo, Mr. Fujii?

Speaking of the Japanese yen… The yen reached an 8-month high of 89.30 overnight.

Lately the yen has gotten a lot of love from Japanese exporters. Recently exporters have been repatriating their profits in yen, ahead of the end of the month / quarter.

I had to laugh out loud when I read a story about the Japanese Finance Minister, Fujii, who apparently hadn’t gotten the memo about how Finance Ministers are supposed to jawbone the yen lower. He has said over and over again that he supported a strong yen.

Well that all changed once he got the “memo.” Fujii said last night that, “people were mistakenly saying he supported a strong yen.”

Hey Fujii, got the memo now? Is it clear? Crystal. Okay, now go out there and jawbone the yen weaker, or you’ll be falling on a sword!

We Have Another Worldwide Watchdog…

Well, the highly touted G-20 meeting last week ended not with a bang, but with some newfound strength as a group.

G-20 ended with leaders from the G-20 nations saying that they plan to cooperate to overhaul financial regulations. They want to prevent arbitrage in the global system. By the end of next year, banks will be required to hold more capital, and compensation policies will need to be linked to longer-term performance.

You know, when the media reports “bankers compensation” they’re not talking about real bankers, per se. They’re referring to the Merrills and Goldmans of the world that pay out billions in bonuses, or did at least.

Just thought I would clarify that point…

That’s it for today… A great weekend, even with the rain on Saturday! It rained so hard that my son’s football game was stopped, and they had to pick it up and finish it yesterday. When I played football, back in the dark ages, we played in any kind of weather. That was a long time ago! It cleared up for a wonderful Saturday night block party with neighbors. As of yesterday, Cards are Central Division Champions! (They were picked to finish 4th in this division.) Now, it’s onto the playoffs. Memo to self: Got to find some way of getting playoff tickets…

I hope your Monday is Marvelous!
Chuck Butler

P.S. I’ll be speaking at our upcoming seminar in Los Cabos, Mexico this November. Along with all the offshore experts, who will be giving you the skinny on how to secure legal tax breaks, set up bank accounts abroad, and plan your estates, I’ll be telling you how to make the most of the dollar’s next fall. Get all the details on this event here.