In Japan, a Robust Yen Undermines the Markets

In Japan, a Robust Yen Undermines the Markets

TOKYO — Tumbling stock markets and falling currencies are causing global concern, but the Japanese yen is generating high anxiety for rising too much. The yen surged as much as 10 percent against the dollar last week. In the last month, it has gained an astounding 34 percent against the euro.

One reason the yen is rising is investors’ flight to quality. Another reason, many economists say, is the sudden end of one of the world’s biggest easy-money schemes, the so-called yen-carry trade.

The yen’s rise helped hammer Tokyo’s beleaguered stock market Monday. Share prices hit a 26-year low and are down 50 percent this year. A strong yen makes Japanese products more expensive during a recession in Europe and North America, hurting the profits of Japanese exporters.

Finance ministers from the world’s seven wealthiest nations issued a joint statement as the Tokyo market sank, saying they were “concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability.” But the yen remained strong as investors signaled their doubt that governments would intervene to stop the yen’s gains.

Christine Lagarde, the French finance minister, confirmed as much in an interview with Bloomberg News.
The yen’s rise is owed, in part, to its status as a safe haven — in turbulent times, investors move money into the currency because Japan is the world’s largest economy after the United States’, and its banking system has limited exposure to the subprime crisis, even though it faces recession.

But currency analysts say most of the yen’s recent gains are because of the abrupt end of the yen-carry trade.
For much of this decade, Japanese and foreigners alike borrowed money in Japan, where interest rates were very low and money was therefore cheap. They invested that money in higher yielding assets across the world, from home loans in Budapest and Seoul to equities in Mumbai.

This turned Japan, with its $15 trillion in personal savings built up by the nation’s chronic trade surpluses, into a provider of low-cost capital for the rest of the world.

No one knows for sure how large this outflow of yen was.

Much of the yen-carry trade took place beyond public scrutiny, in the form of currency options or other types of derivatives trading. Most analysts agree its size was in the hundreds of billions of dollars, with some estimating it reached well more than half a trillion dollars. As the yen-carry trade grew, currency analysts warned it was a bubble of cheap credit, which one day would burst.

Now that day has come, say currency analysts and economists. Investors have been unwinding their yen-based loans as part of a panicked flight from risky assets — like Budapest home loans and Mumbai equities — and into safer havens like the yen and the American dollar, which is also rising against the euro and British pound.

The prospect of global recession has also led central banks in many countries to cut interest rates, reducing the appeal of borrowing in Japan: South Korea cut interest rates by three-quarters of a point Monday, its biggest one-day move ever.

The result has been a huge reversal in the flow of money, back into Japan and its currency. “This is the end of the yen-carry trade, and the yen bubble,” said Tohru Sasaki, chief exchange strategist in the Tokyo office of JPMorgan Chase Bank. “The yen is coming back home.”

As this money flows back into Japan, currency analysts expect the yen to keep gaining. Mr. Sasaki says his company’s forecast is 87 yen to the dollar, but it could go as high as 80 yen.

Mr. Sasaki said the size of the yen’s rise in recent weeks suggested that at least several trillion yen, or tens of billion of dollars, had flowed back to Japan. He said the last time he had tried to calculate the size of the entire yen-carry trade was three years ago, when he estimated that it totaled 40 trillion yen, or $425 billion. He said it could have easily grown much larger than that in recent years.

All this money from Japan added to an excessive abundance of cheap capital that many economists now blame for causing the current financial crisis. Some of the biggest players in the carry trade were American and European hedge funds and banks. But Japanese individuals also fed the outflow of yen by pouring their savings into overseas investments, like emerging markets funds, in search of higher returns.

Japan’s normally conservative homemakers even got into the act by trading foreign currencies online, becoming a force in global foreign exchange markets, known collectively as the Mrs. Watanabes.

One indicator of the recent return of money to Japan has been a surge of individuals here cashing out of mutual funds that invest overseas. A survey of Japan’s 40 largest such funds showed individuals had withdrawn more than $3.5 billion since Sept. 12, Mr. Sasaki of JPMorgan said.

The end of the yen-carry trade could have serious consequences, economists say.

In Japan, the higher yen has worsened the already darkening outlook for the nation’s export-driven economy, hurting companies like Toyota and Sony. The yen, and the prospect of a recession in crucial overseas markets like the United States, have helped drive the benchmark Nikkei 225 index down some 50 percent so far this year.

Globally, the carry trade’s demise could contribute to an overall increase in borrowing costs, especially for developing countries and lesser-known companies in developed nations, by cutting off a major source of low-cost capital, economists say.

“The unwinding of the yen-carry trade is just one more way of taking excess credit out of the system,” said John Richards, head of Asia research at the Royal Bank of Scotland’s Tokyo office. “Higher borrowing costs will go up disproportionately for riskier investments.”

A major reason for the end of the yen-carry trade has been a narrowing in the gap in interest rates between Japan and other developed countries. For years, Japan’s low interest rates — the benchmark overnight rate is 0.5 percent — were attractive enough to entice investors to borrow money here and invest it in countries with higher rates of return, despite the foreign exchange rate risks.

Now, investors are unwinding those loans as interest rate differences between Japan and the rest of the world shrink, making yen borrowing less lucrative. When its board meets later this week, the United States Federal Reserve is widely expected to cut its overnight rate again, from its current rate of 1.5 percent. That is already way down from 5.25 percent when the subprime problems first hit financial markets in July 2007.

Since that time, the yen has risen 24 percent against the dollar as investors have repaid their yen borrowings. Indeed, some currency analysts said this dissolution of the yen-carry trade may already be reaching its climax.
Koji Fukaya, senior currency strategist in the Tokyo office of Deutsche Bank, said he expected the yen’s gains to continue into November, before settling down at a value of about 90 yen a dollar.

“The unwinding and liquidation will continue for a few more weeks,” he said. “Most of the yen-carry trades have already been unwound.”

Dollar and Yen Soar as Other Currencies Fall and Stocks Slip

Dollar and Yen Soar as Other Currencies Fall and Stocks Slip
By MARK LANDLER and VIKAS BAJAJ

WASHINGTON — Fear that the financial crisis is infecting once-healthy economies created another white-knuckle day for investors Friday, causing stocks to tumble from Tokyo to New York.

Uncertainty also roiled currency markets as investors continued to turn to the security of the United States dollar and the Japanese yen and drove down currencies of developing countries like Brazil, Ukraine and South Korea and even of developed countries like Britain.

In the United States, where the crisis began, investors were less alarmed than elsewhere. A rout in Asian and European stock markets sent the Dow Jones industrial average swooning by more than 500 points in early trading in New York, but trading recovered enough ground through the day to leave the Dow down 312.30 points, or 3.6 percent.

Just a year ago, a drop of that size would have been considered a black day in the markets, but in these days of routine triple-digit declines, it offered a modicum of relief to traumatized investors.

Still, there were chilling new developments that attested to the wide scope of the crisis, despite efforts by heads of state, central bankers and corporate leaders to stop the bleeding. Cash flowed into the dollar and the Japanese yen, the two most sought-after safe havens in a storm-tossed world, as it fled from emerging markets.

Hedge funds and other investors are pulling money out of these countries on an immense scale, analysts said, and putting it into dollars and yen. There were few safe harbors, as commodities also tumbled. Fears of a spreading global recession caused oil prices to fall 5 percent, to $64.15, even after OPEC, the oil cartel, announced it was cutting output. Government-backed mortgage bonds and debt issued by top-rated corporations were also dragged down in the undertow.

“This is a panic in the way of the fine 19th-century panics, where we all run around like headless chickens,” said R. Jeremy Grantham, chairman of the Boston-based investment firm GMO, who had predicted stocks would tumble. “I have been in the business for 40 years, and I have never seen anything like this.”

So great are the concerns among policy makers about the turmoil in currency markets that it has prompted talk of a coordinated intervention by the leading industrial countries in coming days, to quell the soaring dollar and put a floor under emerging-market currencies.

Such a move — in which the Federal Reserve and other central banks would sell dollars and yen and buy other currencies — has been used extremely sparingly by the United States in recent years.

“The risk is huge, but it is appropriate at this point, because if the emerging markets go into default, the consequences would be catastrophic,” said Kenneth S. Rogoff, an economist at Harvard.

When a developing country’s currency loses value rapidly, it impedes the ability to pay back loans from Western banks. That could cause a rash of corporate or even government defaults — a feature of previous financial crises in Asia and Latin America.

In the United States, the rescue effort may also grow. The Treasury Department, officials said, is weighing whether to expand its program of capital injections to encompass insurance companies, many of which own savings and loans, and is under pressure to include the financing arms of the auto companies. The government injections are currently reserved for banks.

The Treasury secretary, Henry M. Paulson Jr., appears to be drawing the line at investing in hedge funds, which, officials note, do not supply credit to the economy and are in the business of taking on large risks.

Indeed, hedge funds accounted for some of the turmoil on Friday. They are being forced to sell their stocks, bonds and other instruments to pay off their investors and lenders. Beyond that, investors are increasingly convinced that the global economy is headed for a long, painful recession.

“There has been tremendous activity in the currency markets, the commodity market and the stock market that reveal the fingerprints of forced selling,” said Marc D. Stern, chief investment officer of Bessemer Trust, an investment firm based in New York.

The flight to safety is hurting once-mighty currencies like Britain’s pound. On Friday, worries about how the financial crisis would affect Britain’s economy caused the pound to lose 8 cents against the dollar, falling to $1.53.

While a strong dollar might be a boon for American tourists abroad, it creates a host of problems for economies.

And the downdraft of the pound and the euro — which fell to $1.26 against the dollar on Friday, its lowest level in two years — is less serious for the economic well-being of Britain and Europe than the deterioration of currencies like the Mexican peso or the Russian ruble.

Even if the Federal Reserve, the Bank of Japan and other central banks intervened in the foreign-exchange markets, it was not clear that it would reverse the pressure on these currencies.

“I don’t see this as a crisis breaker,” said Simon Johnson, a former chief economist at the International Monetary Fund. “But it would help emerging-market companies, and give everyone a chance to catch their breath.”

The last time the Federal Reserve intervened in currency markets was in September 2000, when it teamed up with the European Central Bank and the Bank of Japan to shore up the faltering euro. Before that, the United States and Japan teamed up to buy yen during the Asian crisis in June 1998.

With President Bush convening a meeting of the Group of 20 nations in Washington on Nov. 15, analysts said there would be pressure on the United States and other Western countries to show they were trying to cushion the blow of the crisis on developing countries.

The International Monetary Fund is trying to arrange a large credit line to help developing countries desperate for dollars. On Friday, Iceland announced it had reached a tentative deal for a $2 billion emergency loan from the fund — making it the first country to seek aid from the fund during this crisis, and the first Western country to do so since 1976.

The bad news started early Friday in Tokyo and Seoul, where big companies like Toyota, Sony and Samsung disappointed investors with their earnings. It continued as trading opened in Europe, with Britain reporting that its economy shrank in the third quarter.

By the time investors awoke in New York, stock futures had fallen so far that trading in them had been halted. Investors were on notice that the market could fall at least 6 percent, perhaps much more.

As trading started, the Dow dropped 450 points, or about 5 percent, and the floor appeared calm. Some traders said they took solace in the fact that the decline had not been greater — and far from the 1,100-point drop that would force a trading halt on the Big Board.

“It was frightening, absolutely frightening,” Warren Meyers, a floor trader for Walter J. Dowd Inc., said early on Friday. “Every day we are walking on shaking ground.”

Stocks seesawed for much of the rest of the day. A report that existing home sales jumped 5.5 percent in September as banks unloaded foreclosed homes did little to help the market.

But at about 2 p.m., stocks started rallying, and by 3 p.m., the Dow was down by just 100 points for the day. It was unclear what was fueling the rally, though investors seemed cheered by reports that the Treasury was weighing investments in insurance companies.

The Dow, however, was not able to build on those gains and fell sharply at the end of trading, dropping 183 points in 10 minutes.

The Treasury’s benchmark 10-year note fell 3/32, to 102 18/32, and the yield, which moves in the opposite direction from the price, was at 3.69 percent, up from 3.67 percent late Thursday.

As is often the case when stocks fall steeply, the market is starting to entice some investors, many of whom say they have never seen prices so low, to buy. Among them is Mr. Grantham, the GMO chairman.

After years of warning that stocks were unreasonably overpriced, he said he now believed they were below their fair value and had been slowly acquiring holdings in blue-chip companies.

“It’s a very nerve-racking time to be a value investor,” Mr. Grantham said. “You put a little bit into the market, and the next day you think, ‘What an idiot, what an idiot.’ ”

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