Published October 31, 2008

Relief worldwide as galloping yen stumbles

Hope stirs that messy unwinding of carry trades can still be avoided

By LARRY WEE
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(SINGAPORE) Asian currencies rallied yesterday on news of more rate cuts overnight, but the biggest relief came from the cut that Tokyo is expected to unveil today. The possibility that Japan will trim its already rock-bottom 0.5 per cent interest rate halted the relentless march of the yen in its tracks. It also revived hopes that a disorderly unwinding of the carry trade can be avoided.

Currencies that had suffered the worst effects of carry trade reversals over the past week recovered sharply versus the Japanese unit in Asian trading yesterday.

In recent days, the razor-sharp yen has touched multi-year peaks against several currencies. This trend screeched to a halt yesterday as the yen slipped between 13 and 19 per cent versus currencies like the euro, pound and Australian dollar - compared to its recent highs.

Versus the Singapore dollar, the Japanese unit also fell as much as 11 per cent from last week's S$1.6645 highs per 100 yen, trading back to an intra-day low of below S$1.48 before finishing the day above S$1.49 again.

This reversal has huge implications. A popular currency strategy of the past two years has seen investors in Japan and elsewhere sell the low-yielding yen in favour of high-yielders such as the Antipodean pair, the British pound and the euro. Of late, the carry trade seemed to be unwinding with devastating effects as Japanese investors pulled their currency back home - strengthening the yen and sending other currencies plunging.

'The odds for stability to return to global financial markets should increase if market believes that the unwinding of yen carry trades may have run its course for now,' DBS researchers said yesterday.

'If so, look for the US dollar and yen to return their ill-gotten gains, allowing other currencies to recoup their recent losses.'

This is crucial because the surging yen has made an already bad global situation worse all round, by creating a vicious circle that threatens to send Japanese stocks ever lower: As the yen strengthens, Japanese exports suffer, the Nikkei tumbles, and Japanese investors rush more money home from overseas. This creates even more demand for the yen, making it stronger still while weakening other currencies - and pushing the Nikkei even lower.

Meanwhile, another vicious circle is created elsewhere: The more stocks and currencies in other countries tumble, the more nervous hedge fund investors rush to redeem what's left of their hedge fund holdings, and the more assets their hedge fund managers have to sell off to raise cash for such redemptions - which only makes matters worse for them again.

The hope that Japan will prevent a messy unwinding of the carry trade added to the general sense of relief yesterday.

On top of rate cuts by China, the US and Norway on Wednesday, both Taiwan and Hong Kong followed suit in Asia yesterday, and some believe that other European central banks may act by next week as well.

The US central bank also announced swap agreements of US$30 billion each with the central banks of Korea, Singapore, Brazil and Mexico.

South Korea's key Kospi stock index and the Korean won both soared more than 10 per cent yesterday, relieved that the Fed announcement offers a fresh supply of much-needed US dollars to Korean banks - which are believed to be heavily dependent on short-term US dollar borrowings to fund their assets.

Locally, yesterday's sharp rebound of almost 9 per cent for the local STI pressed the US dollar more than four Singapore cents lower from Wednesday's Asian close of S$1.5012 at one point, before it ended the day 2.2 per cent weaker at S$1.4689. Traders also suggested that a weaker Wall Street close - after early Wednesday gains of more than 3 per cent, may have also been a factor.