Strategies correlate after credit market crunch hits

Strategies correlate after credit market crunch hits

http://www.ft.com/cms/s/d2acecf2-4127-11dc-8f37-0000779fd2ac.html

By Peter Garnham and Paul J Davies

Published: August 2 2007 21:39 | Last updated: August 2 2007 21:39

The sudden switches in the flow of cash from leveraged investors have thrown up some surprising correlations and trading tactics in recent weeks.

One London-based credit strategist relates how, for reasons of compliance, his desk was moved next to his bank’s pool of currency traders to ensure a safe distance from his credit trading colleagues.

When turmoil struck the credit markets a couple of weeks ago, the dealers trading dollar/yen, realising who he was, asked him for his best feed on movements in the iTraxx Crossover index, the barometer of risk appetite in credit.

The currency traders had realised it was also a strong indicator of hedge fund de-leveraging, which for people trying to judge movements in the carry trade is the crucial factor.

It soon became apparent that other currency traders at other banks had cottoned on to the same idea.

The clue was that everybody seemed to be relying on the same iTraxx feed from Bloomberg, which is delayed by about 10 minutes from what in a non-centralised market comes closest to a live price.

“We realised this because twice in the same day we saw the biggest single moves in dollar/yen that anybody had seen in months almost exactly 10 minutes after huge moves in the Crossover,” the strategist says.

The story illustrates the central role that levered investors are playing in the volatility across asset classes.

The behaviour of the yen versus other major currencies in recent weeks is very much tied to these investors’ carry trade strategies.

A combination of low Japanese interest rates and subdued volatility pushed the yen to multi-year lows against a range of currencies as the Japanese currency was sold to fund the purchase of riskier, higher-yielding assets elsewhere.

But turmoil on global asset markets has seen a scramble to take some of that risk off the table, with leveraged funds taking profit on carry trade positions.

This has sent the yen up 2.1 per cent against the dollar and a whopping 6.5 per cent against the higher-yielding New Zealand dollar since the start of last week.

However, how much further the yen can climb is open to question.

Paul Chertkow, head of currency research at Bank of Tokyo-Mitsubishi UFJ, says profit-taking by funds outside Japan is unlikely to prove the catalyst for the demise of the yen carry trade.

“The yen carry trade is grounded not in leveraged funds outside Japan but in Japanese retail investors,” he says.

In contrast to leveraged investors, real money investors in Japan have been happily selling the yen even as it has been rising, taking their bets against the Japanese currency to record levels this week.

Mr Chertkow says these retail investors have been relatively insensitive to recent currency swings since they are principally chasing the yield on offer outside of Japan.

Also, the proportion of their wealth held outside the country – estimated to be about 7 per cent – was still relatively small, although it was rising quickly.

Edited 1 time(s). Last edit at 08/03/2007 01:21AM by regli.