Yen rally continues after U.S. data: Is the Carry Trade affecting the global equity markets?

Yen rally continues after U.S. data
By Leslie Wines
Last Update: 8:44 AM ET Aug 16, 2007

NEW YORK (MarketWatch) - The yen remained sharply higher against its rivals early Thursday, after data showing that housing starts dropped to a 10-month low last month. Another report showed that claims for unemployment benefits last week hit their highest level since mid-June. The data did not have its usual impact on the market because investors' attention remains trained on turmoil in the credit markets. Shaky credit market conditions are forcing investors to unwind carry trades in which they borrow yen to buy higher-yielding assets.

The shakiness also is sparking heavy purchasing of government-backed Treasurys, a phenomenon that is lifting the dollar a bit against the euro and pound. At last check, the euro was down 0.02% at $1.3426, the dollar down 1.4% at 114.57 yen, and the pound sterling down 0.09% at $1.9855.



GOIH Commentary:

As we have reported in the past, we believe the Yen carry trade is the global liquidity window funding the global equity markets recent assent. We have said before that astute investors borrow in the Japanese market at 1% and invest in higher yielding assets. The interest rate risk is minimal since that can be hedged, allowing an investor to speculate on exchange risk which can also be hedged with forward contracts.

In essence astute investors borrow the Yen, invest in Australian fixed income products yielding 9%, and use the Australian fixed income instruments as collateral to invest in US equities, thus causing the Dow and NASDAQ to make new highs each day in June and July.

As we at Global 1 Financial see things, we are forecasting continued disruptions in the US housing market since the subprime lender and borrower are effectively shut out of the market, thereby eliminating any marginal increase in housing starts.

We are beginning to see stress in the consumer retail stocks, thereby the consumer is beginning to feel the affects of the economic slow down. Because the consumers' wages have been flat, the source of funding for the consumer has been the equity in their home. But because home values have begun to decline the retail consumer is not able to make retail purchases funded by home equity, thus causing the slow down in consumer spending and the slow down in consumer stocks.

We see consumer retailers weak for the third quarter and continuing into the fourth quarter. We especially see Home Depot (NYSE:HD) and Lowes (NYSE:LOW) weak as consumer retailers in the home improvement sector.


GOIH Global Economics