Barclays Says Yen to Drop to 125 on Shift in Savings

The yen will slump 5 percent this quarter, the worst start to a fiscal year since 1989, as Japanese invest more of their savings overseas, said Toru Umemoto, chief foreign-exchange strategist at Barclays Capital.

Individuals are seeking higher yields because the Bank of Japan may not raise its 0.5 percent benchmark interest rate until the third quarter, said Umemoto, the most-accurate yen forecaster last year in surveys by Bloomberg News. The currency will drop to 125 against the dollar, he said, the weakest since December 2002.

The yen has fallen against the 16 most-actively traded currencies over the past month, with the biggest losses suffered against those with higher yields such as the Australian and New Zealand dollars. Households gained confidence to invest offshore after Japan's economy grew at the fastest pace in three years in the fourth quarter, said Umemoto.

``The yen's downtrend will continue as Japanese, who are fed up with low returns, will continue to export capital,'' Tokyo- based Umemoto said in an interview on April 2. ``Individuals will play the leading role.''

Overseas assets held by Japanese households reached 46 trillion yen ($387.6 billion) in 2006, only 3 percent of their total financial holdings, based on Umemoto's own calculations.

`Not Particularly High'
There is ``room for households to shift money from safe but low-return deposits to riskier, higher-return assets abroad,'' said Masafumi Yamamoto, a strategist at Nikko Citigroup Ltd. in Tokyo and a former Bank of Japan currency trader. ``The Japanese ratio at 3 percent does not look particularly high.''

Yamamoto is less bearish on the yen than his counterpart at Barclays, predicting the currency will fall to 119 a dollar by June 30. He said Japanese overseas holdings rose 27 percent last year from the previous year, citing data compiled by the Bank of Japan, monthly data from the Investment Trust Association Japan, and Citigroup's own estimates.

Japanese mutual funds boosted purchases of assets abroad to about 40 percent of the total from about 8 percent in 2002, according to the Investment Trust Association. The mutual funds now have about $244 billion of assets denominated in foreign currencies, including $98 billion in the U.S. dollar.

Higher Yields
The yen weakened 6.0 percent versus the New Zealand dollar and 5.5 percent against Australia's currency in the past month. Australian and New Zealand 10-year government bonds both offer a yield premium, or spread, of 4.20 percentage points over similar- maturity Japanese debt. Securities in Germany give an extra 2.4 points.

The ratio of Japanese household savings parked in banks and post offices accounted for about half of their total financial assets of 1,550 trillion yen, compared with 10 percent in the U.S. and 30 percent in Europe, Barclays' Umemoto said. That will continue to decrease as more funds go abroad, he said.

Credit Suisse and Fortis Bank were the two most bearish for the yen among 49 contributors to a Bloomberg survey last month, forecasting losses to 125 and 127 against the dollar this quarter. The median estimate was 117.

The yen gained 1 percent last quarter as some global funds exited carry trades, where they borrow and sell yen for better returns elsewhere, because of a global slump in stock markets. Local Japanese investors are taking their place with their own form of carry trade. (Bloomberg)

YEN CARRY TRADE

The Yen Carry Trade is simple....................

Right now, big investors can borrow Japanese yen at an interest rate of 0.5%. As long as they can invest that in something that pays more, they can earn the spread, or "carry." It's usually done by investing in U.S. dollars that pay 5%.

In other words, big investors simply borrow yen at 0.5%, invest in dollars paying 5%, and pocket the difference. They do it with leverage, so the returns are magnified to be phenomenally profitable. As long as the dollar and the yen are relatively stable, the profits are huge.

At first, investors just did it by selling yen and buying U.S. Treasuries. But steadily, investors have borrowed yen to take on more and more risk including buying stocks in China and India.

The leverage these guys take on magnifies the risks...
If the dollar strengthens versus the yen, the profits just get silly. But if the yen strengthens versus the dollar, these big investors can lose a substantial amount of money. The yen has been weakening for a long time, so this risk hadn't shown itself until investor in china got scared.

So, If you had borrowed a mountain of money in yen, you were now in the red, big time. You absolutely had to close out your carry trade to cut your losses before they became too great.

The initial trade was to buy Chinese stocks and sell the yen (the carry trade portion). So to close out that trade, investors had to sell Chinese stocks and buy the yen. Therefore, yesterday Chinese stocks crashed (triggering a domino effect throughout the world), and the yen soared. Plain as day. The success of the Yen Carry Trade created a self-perpetuating cycle. The trade's
success attracts more people, which weakens the yen and makes the trade more profitable. That, in turn, attracts even more people. The yen is now incredibly weak it's cheaper than it was before the Plaza Accord in 1985 (on a trade-weighted basis). It soared by 100% against the dollar after that.

In short, the Yen Carry Trade has created a flood of money around the world, looking for any investment that can make more than 0.5%. In other words, just about anything For example, high-yielding currencies, like the New Zealand dollar, have appreciated significantly. Yields on real estate in developed markets have fallen to all-time lows. And debt-funded private-equity deals have risen to all-time highs.

Asian economies like Thailand, China, and India are now facing an unprecedented "problem" of excessive money inflows. India, for its part, appears to have benefited significantly from the carry trade. The huge influx of money has created a benign interest rate environment that has fueled consumption and investment.

All the easy money entering India has fueled a boom that has used up all the "slack" in the economy. India has the raw human capital and the potential to produce all the goods and services that are in now in short supply. But there are numerous structural problems with the economy, mostly related to the government. These problems are easy to gloss over when money is easy, as it is now. But to me, the structural problems and the easy money combined are a potent mix that will become a problem for the Indian economy. It's already starting. For example, wages are growing at 20% a year. Property prices and housing costs for urban India are exploding. Headline inflation is at 6.73% (which grossly understates real inflation),
but short-term interest rates are excessively low at 7.5%.

I am not bearish on India; I believe it is one of the best economic growth stories for this century. It also has one of the best pools of human talent, entrepreneurs, and companies in the world. But the excess speculative money that's now here, caused significantly by the Yen Carry Trade, is getting carried away with the India story. It ultimately will do a disservice to India, causing our economy to overheat. The financial community is driven by fads and trends just like any other social community. Shifts between fads can be sudden and unpredictable and can have serious implications for investors, particularly in emerging markets. Given the problems the carry trade is beginning to create everywhere in the world, and given the almost one-sidedness of the trade, it is time to start taking the opposite view and to hold tight for what is likely to be the mother of all reversals.

I don't know if the 8.8% one-day fall in China or the fall in the Dow was the beginning of the end of the carry trade.
(source: from web)

One thing is for sure the risk appetite of global investor is going to change after this reversals. The little spreads in the assets class will now improve. Even though the story of India and china is very strong, but risk appetitie of global investor will come down. The stock in this economies
were trading after discounting 2009 and 2010 earnings. Atleast this situation will change.