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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Are We Ready for Another Yen Carry Trade Stock Market Plunge ?

Stock-Markets / Financial Markets Apr 19, 2007 - 01:33 PM GMT

By: Christopher_Laird


With the Asian markets all down heavily last night, and the Yen strengthening again, I thought to talk about another possible Yen carry related market sell off.

China bubble trigger
A month or so ago, Premier Wen of China said that their manufacturing and financial bubbles were unsustainable and out of control. This was in light of recent financial tightening in China, increasing reserve requirements for banks to over 10% now, and raising interest rates moderately. It is important to realize that China is determined to do something about their financial bubbles.

The trouble is, there is so much hot money flowing into China, and that combined with a bubble mania in financial assets as well as manufacturing and stocks by Chinese has created a flood of money flowing into their markets.

Since the last year the Shanghai stock index is up over 150% - again at an all time high right now. The recent panic 9% sell off that Tuesday a month or so ago led to a about of panicky selling in Asian markets in general. That both led to and was caused by a rising Yen after the EU stated several months ago that investors should not ‘make one way bets on a weak Yen'. Soon after that statement, there was the Shanghai stock sell off, Asian stock sell offs, and other world sell offs. Eventually, things stabilized, but it took over two weeks of Central bank efforts and calming to stem the repeated bouts of selling into markets world wide.

The US stock market at that time, though initially falling 500 points in the beginning of the mess, stabilized, and every time it failed to follow through on Asian sell offs the night before, the Asian markets subsequently calmed the next day.

That was our last bout of sell offs

But, that was that bout of selling. Now, with markets again at new highs, the Dow, and Shanghai, (up to today when it dropped over 4% again) seemed to flow ever higher, oblivious of the danger of any new bouts of Yen strengthening.

Well, we again have many of the same factors gathering for another bout of Yen strengthening, and related stock and financial market sell offs….

First, the Yen has been very weak and is very undervalued for YEARS. China, the EU, and every major trade partner of Japan is not liking this one bit. The Yen has a lot of reason to strengthen, not to mention the gigantic scale of the Yen carry that has built up in RISING stock markets all over the world in the last years.

The overall situation is that markets are heavily infected with leverage. I don't care if many of them mare making new highs again. Well, a few months ago they all made new highs, then we had that bout of Asian selling and Yen carry unwinding that led to weeks of stock drops a month or so ago that bad Tuesday. Now, markets have recovered to new highs, - except that now the Asian markets are just crashing again now – and maybe all we saw was a double top in these new highs?

It certainly would fit the idea of a pending second wave of Yen carry unwinding to come.

In the last few days, the Yen has strengthened very roughly 1%. It had been on a rather long downwind to about 83.5 on the $XJY.

IF the Yen begins another bout of strengthening, look out. We may have just seen the beginning of another –rather overdue- bout of Yen strengthening and Yen carry unwinding.

The thing is, with markets to toppy right now, it does not take a lot to cause new Yen carry unwinding…

Yen Carry monster is a hungry one!

Either there is a push to sell and capture profits – which puts upward pressure on the Yen as carry is paid off, and then puts more downward pressure on the financial markets, and or, because Yen strengthening itself causes more selling of Yen carry and then more Yen strengthening. As a matter of fact, once any Yen carry unwinding starts, it is almost impossible to stop before serious carnage accumulates in financial markets.

This is one reason why the G7 and EU have toned down their rhetoric about Yen carry and a too cheap Yen in the last meeting this month….the last time they directly addressed ‘one way bets on the Yen' (referencing all that Yen carry trade infecting markets) we had the last bout of Asian stock crashes…..with unwinding Yen carry eating up the world markets for weeks before things calmed down.

But I don't think that merely pretending not to see the big elephant about to turn around in the china shop called the world financial markets is going to stop him from turning around….

Cover your eyes maybe.

But anyway, the ingredients are once again gathering for another bout of Yen strengthening and financial/stock sell offs. Of course, gold would take a hit initially if there are serious stock sell offs coming again. Gold is a liquid asset people can use to cover margin losses.

But, we have again the same situation before the last bout of Asian crashes recently:

  • Recent Gold and PM profits
  • Stock profits – ripe for profit taking
  • A rising Yen again.

By Christopher Laird

© 2007 Christopher Laird. All rights reserved.
Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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