Thursday, June 16, 2011
Carry Trade Part.III
This trend leads to a significant increase in financial markets, coupled with the disappearance of the concept of risk in the minds of market players due to a depletion of non cash flow. However, a decline of return on financial markets, a sudden reversal of the market, would result in substantial losses for investors, given the high level of leverage and risk now borne in the carry trade. Such a situation would cause a repositioning of investors followed by a rapid and concomitant unwinding of positions in many currencies.
The lower level of liquidity resulting from this movement would affect all markets and could be the detonator of a global currency crisis or a global economic crisis. The same situation was experienced in 1997-1998 in Asia while the yen carry trade operations had already been implemented and that the Russian market, object placement, had fallen sharply. Today the extent of yen carry trade is more important and the crisis would reach Europe and the United States, countries in which investments are made.
Against a backdrop of continued increase in U.S. and European markets, increasing the risk borne by financial transactions recently introduced, the Japanese monetary policy is closely watched by central banks. To prevent slippage of the financial markets, a gradual closing of the "tap" cash is needed and must go through a rate hike. However, the continued movement deflation in Japan does not motivate a significant rise in interest rates. Japan cannot afford to hire a genuine policy of monetary tightening; the Bank of Japan announced Feb. 21 an increase of 0.25% and should not go much further in the short term.
Several questions arise: what are today the real levers available to the Bank of Japan? Central banks have they any means to influence the global liquidity? Is it too late to avoid the worst?