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Rediff.com  » Business » Carry trade: Re not to be hit

Carry trade: Re not to be hit

August 30, 2006 16:36 IST
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Ashley Davies of UBS says that significant outflows from Japan indicates resumption of carry trade, and adds that he is bullish on the yen.

He says that a marginal impact on the rupee is seen due to carry trade, but no major volatility is seen in forex markets due to the same.

Excerpts of CNBC-TV18's exclusive interview with Ashley Davies:

Is there any anecdotal evidence to suggest to you that maybe this trade is opening up again, the yen carry trade?

Certainly, this year we have seen significant outflows from Japan on the short-term bank lending side. So that is a very strong indication that there has indeed been a sizeable carry trade affecting the markets and keeping the yen persistently weak this year.

What's been the experience in the last one month; could you tie in the recent movements of the yen versus other currencies and whether it is suggesting that it is getting more attractive to do that carry trade again?

There has been a significant carrying back of rate tightening expectations from the BoJ. So if you look at the yen weakness that we are seeing, that can almost entirely be explained by a shift in new differentials in favour of foreign currencies over the yen. So that has certainly been an effect.

I am estimating an order of about 3-4 trillion yen in outflows each month from Japan, which probably one could attribute to the short term bank lending abroad, which is probably the best proxy for carry trade.

Would you have anecdotal evidence of which financial assets this money is coming into now?

We don't have a very good breakdown as to where the data goes. All we know is that there are outflows from Japan, but the actual breaking down of where it ends up is quite difficult to discern.

I don't want to overemphasize this too much. I don't want to say that given the sort of mal-trajectory that we have got for the BoJ, its rate tightening has caused massive disruption to global markets. It has been an element, but I am not saying that we should be expecting a huge rise in volatility in the fixed markets as a result.

There were some fears actually in the last couple of months that maybe the liquidity flows from Japan or out of Japan might tighten a bit in the light of what the BoJ is trying to do and what the currency there is doing. Has that view turned around a bit; do you think that maybe those factors are more benign now to suggest that there could be money, which could be easing out of Japan in the next 3-4 months?

Most of the disruptions in the market that we have seen this year, particularly in May and June, when we saw a tremendous rise in risk aversion, was actually not a function of BoJ policy, it was actually a function of Fed Reserve policy.

People were very confused about the Fed outlook and the communication strategies of Chairman Bernanke. So probably the BoJ has not been a huge influence on the markets so far this year, to the extent that we are seeing periodic episodes of risk aversion.

Then do you expect to see, over the next few months, the average rate of 3-4 trillion yen that you spoke about in terms of flows?

It would probably persist over next month or so, but I do agree that there are awesome risks that are growing. September can be quite an interesting month with the IMF meeting and G7 meeting in Singapore.

Potentially if you have volatility in forex markets, some of those carry trades financed by the yen could unwind. The impact of that would be contributing to the yen's strength.

We actually do have a slightly bullish forecast for the yen in one to three months. I am looking at 114 for dollar-yen. That is in anticipation of the broad dollar weakness in light of event risks in September. We are expecting a broad dollar weakness and the yen should benefit from that, and that would be quite disruptive to carry trades.

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