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Lots of liquidity . . . and, oh yes, that ‘carry trade’

Bob Moon Jun 12, 2007

Lots of liquidity . . . and, oh yes, that ‘carry trade’

Bob Moon Jun 12, 2007


Kai Ryssdal: Let me run a couple of other key words and phrases by you. Liquidity’s a good one to start with. The global cash glut has gotten a lot of the credit for the run-up in the world’s stock markets of late. Tightening’s another one — that’s what’s happening to interest rates right now.

That supply of that cash is getting tighter. And then there are the currency markets. Money itself is a commodity, y’know.

Add ’em all up and what you get out the other side is a stock market that’s not quite sure what’s going on. We’ve got our Senior Business Correspondent Bob Moon here to tie it all together for us. Hi, Bob.

Bob Moon: Hey, Kai.

Ryssdal: All right. So as I said up at the beginning, it’s been five long days now that there’s been this dance between stocks and bonds. What’s going on?

Moon: OK, well join me if you will, Kai, in a chorus of “You Can’t Always Get What You Want . . . But Sometimes You Get What You Need.”

Here’s the deal: Stock market investors have been counting on the economy growing just enough for profits to be good, but they’ve also been hoping that inflation would stay low enough that the Federal Reserve might be persuaded to goose the economy with lower interest rates. Well, over the past week, Mr. Bernanke and company have been sending signals that no, there’s still a real threat from inflation here. And if anything, there might need to be an interest rate increase to keep pricing pressure under control.

So what we’re seeing from investors now that if they can’t get what they want, they’ll get what they need. And that would be decent returns for their money. Hey, if interest rates are gonna go up after all, then a lot of investors seem to be saying, “OK, let’s put our money with those bonds that are increasing their yields right now.”

I talked to University of Maryland economist Peter Morici about this today. He believes we’re seeing a calculated move — literally a move on the part of a lot of investors:

Peter Morici: It’s a market timing issue. Some people try to time the market. They allocate their assets in hopes of maximizing their return in the long run by moving back and forth between stocks and bonds. Of course, you have to be very talented in picking the right time to buy and sell.

Moon: Now, he also says that the fact that interest rates are now widely believed to be headed higher, well that’s brought back another worry for a lot of investors — the dreaded unwinding of the carry trade. That caused a lot of nerves, you might recall, when we saw the stock market take that really big dive earlier this year.

Ryssdal: Mmmhmm. All right, I’ll be honest — you had me right up until you said that thing about carry trade. Remind us what that is, and why it matters.

Moon: OK. Suppose that you go borrow a cheap currency like the yen. The interest rate’s less than half a percent over in Japan right now. So you borrow at that cheap interest rate and then you convert that to dollars. And you invest it here, where your return is gonna be better — or over in let’s say New Zealand, where the interest rate is now around 8 percent. Right.

So that’s essentially free money that you’re getting from that. You’re borrowing from the bank at a cheaper rate and then you’re investing at higher interest rates, you pocket the difference. But here’s the rub: If U.S. interest rates go higher and they start to push the value of the American greenback down, then all those people who borrowed the yen or other cheap currencies abroad are gonna see their margins vanish and they’re gonna have to pay that all back.

And Peter Morici, the University of Maryland economist, says that’s one of the things that’s feeding into the volatile investing climate that we’ve been seeing develop over the last few days:

Morici: The people that are gambling in the carry trade are gambling against a fall on the dollar. At some point, that has to unwind. And some people are starting to get skittish about it right now.

Moon: So you can get really nailed if you’re investing in a currency that right away falls. The carry trade can be very lucrative, but I’ve seen it compared to trying to snatch pennies in front of an oncoming steamroller.

Ryssdal: Let me ask you very quickly now, we’ve got about 15 seconds, when eventually are people gonna stop paying attention to this bond/stock thing and just go about the way business has been happening for the past several years on Wall Street?

Moon: Well, I’ve heard it said that there’s still a lot of cash floating around out there.

Ryssdal: Right, liquidity.

Moon: Liquidity. And that this may not develop into anything big. That it’s a section of the economy, but it’s really just an itch.

Ryssdal: All right. Bob Moon is our senior business correspondent. We call him that ’cause he gets the tough stories. Thank you, Bob.

Moon: Thanks, Kai.

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