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Why the correlation between carry trades and equity markets?

  • Post #1
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  • First Post: Aug 29, 2007 4:39pm Aug 29, 2007 4:39pm
This has probably been answered before, or may be common knowledge to most people here, but I don't quite understand why there is such a precise correlation between carry trade currency pairs (such as GBP/JPY) and global equity markets?

As I understand, the main point of a carry trade is earn the interest differential between two currencies, and also increase the capital due to the appreciation of the high-yielding currency.

The interest rate differential won't go away overnight even if stock markets suffer a big collapse, so why are carry traders pulling out so quickly? Is it just a psychological effect that things are unstable, or are there more profound reasons?
Quoting sgrig
This has probably been answered before, or may be common knowledge to most people here, but I don't quite understand why there is such a precise correlation between carry trade currency pairs (such as GBP/JPY) and global equity markets?
If that helps, here is a simple figure.

In New York markets:the Dow↑→people feel safe→buy foreign currencies(yen selling)→weak yen
In Tokyo market: weak yen→raise expectations for exporting companies(such as Toyota Motors, Sony)→export-related shares↑→weak yen

The reverse case, when the Dow falls sharply, people ensure profits or liquidation of long or blind sale, as a result, it leads strong yen. The strong yen also tend to lead selling export-related shares in disappointment and the stronger yen...downward spiral.
Therefore, the Dow is key(clue to the solution of the downward spiral) and the Dow is all we think about.
Peace and Happiness through Prosperity (by Konosuke Matsushita)
Thanks a lot, Fumafuma. This actually makes sense, since Japan is a very export-oriented economy, a weak yen is good for it, but this is related to the US economy being strong.

But what about CHF carry trades? I know CHF is regarded as a safe currency in times of crisis, so from this point of view it makes sense that it appreciates during volatile times, but is there another reason for this?
My basic understanding is that many investors (not necessarily currency investors) worldwide are using yen to purchase US investments, could be bonds, blue chip stocks etc. This way they have two possible sources of income, the interest from the carry trade and the investment itself. When the Dow for example has a bad day to some degree this could indicate carry trade investors selling their stocks and buying back their yen. At least that is my take.
Quoting saskgui
My basic understanding is that many investors (not necessarily currency investors) worldwide are using yen to purchase US investments, could be bonds, blue chip stocks etc. This way they have two possible sources of income, the interest from the carry trade and the investment itself. When the Dow for example has a bad day to some degree this could indicate carry trade investors selling their stocks and buying back their yen. At least that is my take.
But with GBP/JPY are they buying UK stock and bonds?
→→→ fuma, seems like I learn something new every day... I didn't realize it was possible to insert such cool symbols into posts ↑↑↑
Quoting ycomp
→→→ fuma, seems like I learn something new every day... I didn't realize it was possible to insert such cool symbols into posts ↑↑↑
LOL! My pleasure. But I entered "矢印/やじるし(this Japanese words mean arrows)" with Japanese-language input and expressed "↑→↓←".
Peace and Happiness through Prosperity (by Konosuke Matsushita)
Quoting saskgui
My basic understanding is that many investors (not necessarily currency investors) worldwide are using yen to purchase US investments, could be bonds, blue chip stocks etc.
I don't think is possible to buy US goods with yen. But you can borrow yen(for the low yeld), trade them for dollar and then buy us goods.
"Abandon all hope, you who enter here" La Divina Commedia, Dante Alighieri
Quoting sgrig
a weak yen is good for it, but this is related to the US economy being strong.
not neccesary, a week yen is good between some limits.
By having a verry week currency, imports become to expensive. This is not good for Japan's economy, wich need masive imports of raw materials.

I remember in high-school we were told, that if Japan would use only it's on coal and natural gas, it will empty all it's resources in 2 weeks.
"Abandon all hope, you who enter here" La Divina Commedia, Dante Alighieri
Quoting sgrig
But with GBP/JPY are they buying UK stock and bonds?
Yes to my knowledge.
Quoting semar
I don't think is possible to buy US goods with yen. But you can borrow yen(for the low yeld), trade them for dollar and then buy us goods.
Quite true. You said what i meant to say. Thx for the clarification.
Quoting sgrig
Thanks a lot, Fumafuma. This actually makes sense, since Japan is a very export-oriented economy, a weak yen is good for it, but this is related to the US economy being strong.

But what about CHF carry trades? I know CHF is regarded as a safe currency in times of crisis, so from this point of view it makes sense that it appreciates during volatile times, but is there another reason for this?
I'm sorry for not having answered your post sooner.
Well, I hesitate for an instant because FF prefers specific trading issues. But my trading principle is based on my political and military analyses....
Japanese media often says "If the US catches a cold, Japan will catch pneumonia." As you may know, after defeat in the war(1945) till Peace Treaty signed in San Francisco(1951), Japan was the occupation of the US.
The short answer is that Japan could concentrate on postwar economic reconstruction and rapid economic growth on the coattails of the Japan-US Security Arrangements/under the US nuclear umbrella(my cool-headed figure of this situation:USD>>・・・・・>>JPY). Japanese media is both left-wing and anti-US stance, so they never tell us this point.

Ah, the US accounts for about 30% of the world's GDP, therefore, if the US economy weaks, the effects will spread all over the world of course, because of globalization in the form of an ever-increasing movement of people, goods, money, services and information across international borders.

Um...currently, I trade JPY cross currencies(especially USD/JPY, GBP/JPY). Although I draw also USD/CHF and GBP/CHF daily Point&Figure charts, when unwind yen carry trade, CHF seemed to have moved in the same way. It merits my further research.
Peace and Happiness through Prosperity (by Konosuke Matsushita)
  • Post #13
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  • Last Post: Sep 1, 2007 6:28pm Sep 1, 2007 6:28pm
Thank you very much for your insight, Fumafuma!
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