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If you think stock markets were the only ones that went haywire this week, look again:
The dollar fell sharply, especially against the yen ... Treasury bonds soared, with the long bond gaining almost a point and a half on February 27 alone ... and gold prices swung all over the place.
In other words, volatility went off the charts in almost every market I track. A volatility gauge maintained by the Chicago Board Options Exchange, for example, exploded 63% in a single day, the biggest increase in U.S. market history.
What single force links all this action? What little (or big!) beast could possibly be behind so many seemingly disparate market moves? Here’s my answer …
A Cheap-Money Monster
From the Bank of Japan
Stocks, bonds, high-risk mortgages, and commercial real estate have all climbed, in varying degrees, thanks to a combination of things, including reckless central bank policies and a complete disregard for risk by many professional investors.
But one big stimulant behind the runs we’ve seen in many of the world’s investments is simple — money. I’m talking about pure, unadulterated liquidity. It’s been growing by leaps and bounds here in the U.S. as well as overseas.
Who’s the biggest culprit when it comes to doling out cheap funds? Well, the Bank of Japan certainly belongs on any short-list. The BOJ has kept its short-term interest rates extremely low — near 0% — for a long period of time. And it’s been flooding its domestic economy with liquidity.
Here’s the important thing — all that excess liquidity didn’t just encourage Japanese borrowing and spending. Instead, it gushed all over the rest of the world, unleashing a force called the yen carry trade.
Here’s how it works ...
Say you’re a trader at Goldman Sachs, and you want to make a big bet on U.S. bonds. You’re looking for the cheapest source of money you can find. After all, the more money you can borrow ... and the lower the interest rate ... the greater your potential investment return.
So you sift through international money markets and find out that a Japanese bank that will loan you a couple hundred million dollars at 0.25%. (This is what Japanese rates have actually been for the last few months!)
You receive the money in Japanese yen, then convert the funds into dollars. That’s because you want to buy U.S. bonds.
This strategy can really pay off! After all, short-term rates are 5.25% in the U.S. So, right off the bat you’re earning a 5% return (5.25% - 0.25%). This is called “positive carry.”
If you throw in some leverage, you can double or even triple those returns!
If you decided to invest in another country with even higher interest rates (New Zealand’s current rate is 7.25%), you can really make out like a bandit!
And if you buy something riskier than short-term bonds — say, a junk bond or a complex derivative — you can get an even higher yield (and possibly more capital appreciation, too).
Investors naturally asked themselves: Why not engage in a massive carry trade? Why not borrow for virtually nothing in Japan and leverage that money into all kinds of other assets? After all, it was like free money.
The dollar fell sharply, especially against the yen ... Treasury bonds soared, with the long bond gaining almost a point and a half on February 27 alone ... and gold prices swung all over the place.
In other words, volatility went off the charts in almost every market I track. A volatility gauge maintained by the Chicago Board Options Exchange, for example, exploded 63% in a single day, the biggest increase in U.S. market history.
What single force links all this action? What little (or big!) beast could possibly be behind so many seemingly disparate market moves? Here’s my answer …
A Cheap-Money Monster
From the Bank of Japan
Stocks, bonds, high-risk mortgages, and commercial real estate have all climbed, in varying degrees, thanks to a combination of things, including reckless central bank policies and a complete disregard for risk by many professional investors.
But one big stimulant behind the runs we’ve seen in many of the world’s investments is simple — money. I’m talking about pure, unadulterated liquidity. It’s been growing by leaps and bounds here in the U.S. as well as overseas.
Who’s the biggest culprit when it comes to doling out cheap funds? Well, the Bank of Japan certainly belongs on any short-list. The BOJ has kept its short-term interest rates extremely low — near 0% — for a long period of time. And it’s been flooding its domestic economy with liquidity.
Here’s the important thing — all that excess liquidity didn’t just encourage Japanese borrowing and spending. Instead, it gushed all over the rest of the world, unleashing a force called the yen carry trade.
Here’s how it works ...
Say you’re a trader at Goldman Sachs, and you want to make a big bet on U.S. bonds. You’re looking for the cheapest source of money you can find. After all, the more money you can borrow ... and the lower the interest rate ... the greater your potential investment return.
So you sift through international money markets and find out that a Japanese bank that will loan you a couple hundred million dollars at 0.25%. (This is what Japanese rates have actually been for the last few months!)
You receive the money in Japanese yen, then convert the funds into dollars. That’s because you want to buy U.S. bonds.
This strategy can really pay off! After all, short-term rates are 5.25% in the U.S. So, right off the bat you’re earning a 5% return (5.25% - 0.25%). This is called “positive carry.”
If you throw in some leverage, you can double or even triple those returns!
If you decided to invest in another country with even higher interest rates (New Zealand’s current rate is 7.25%), you can really make out like a bandit!
And if you buy something riskier than short-term bonds — say, a junk bond or a complex derivative — you can get an even higher yield (and possibly more capital appreciation, too).
Investors naturally asked themselves: Why not engage in a massive carry trade? Why not borrow for virtually nothing in Japan and leverage that money into all kinds of other assets? After all, it was like free money.