Street Capitalist: Event Driven Value Investments

Today the Financial Times has a great Q&A with Simon Derrick, head of currency research at Bank of New York Mellon. He’s one of the most listened to commentators on the foreign exchange market.

Currency Markets Q&A

I the following question to Mr. Derrick which was answered during the Q&A.

Some people are making projections that the US will fall into a recession, or at least find itself not being spend as much due to a de-leveraging effect the credit turmoil may have on US consumer spending. Because of this, are you bullish on the Yen and expecting the carry to unwind?
Tariq Ali, Texas

Simon Derrick: Given that the carry trade has been one of the defining trades for the currency markets in the past few years, this is possibly the key question at present. As the carry trade is, inherently, a high risk strategy, one of the basic conditions needed to make it work is that the markets need to be calm if investors are to feel comfortable chasing yield differentials.

A 610 basis point interest rate pick up for holding the Australian dollar and borrowing in yen for twelve months looks considerably less attractive when it is remembered that the Australian unit lost substantially more than this on just one day alone last month. When confidence in this type of trade is lost, it typically takes a number of years to recover. After the collapse of a very similar trend in October 1998 it took over two years for a sustained recovery to emerge.

Given that we are currently in the process of winding up a currency market bubble of substantially greater magnitude than that seen in 1998, it seems reasonable to suppose that the yen still has some way to appreciate.