The Carry Trade Devil in Mrs. Watanabe

♠ Posted by Emmanuel in , at 9/18/2007 03:46:00 PM
No, no, it's not what you think. (For shame!) The IPE Zone hasn't gone "adult entertainment" on you all of a sudden. The IPE Zone is a family-oriented blog, rated PG. Anyway, let me explain what's going on here. I regard the carry trade as DEMONstrated by the likes of the NZD/JPY currency pair as a barometer for speculative foolishness; the higher the NZD/JPY trades, the more disdainful traders become of risk. I have always assumed that hedge funds (most of which are now eating dirt) were behind most of these carry trading shenanigans, but the Economist has other ideas. According to this recent article, it's not faceless, money-grubbing hedge funds that are the key forces driving the carry trade. Nope; it's the archetypal Japanese housewife, "Mrs. Watanabe," who is driving it.

As you all know, Japan has kept its interest rates extremely low for an extraordinarily long time in the hopes that it could escape the throes of deflation. But, as Claus Vistesen over at Alpha Sources would probably point out, low interest rates aren't likely to work; it's a monetary solution to a demographic problem. Suffice to say, it hasn't been solved. So, according to this argument, the average Japanese household has piled on bigtime into the carry trade to gain additional interest income. What am I to make of it? I am undoubtedly biased into blaming hedge funds for this bit of financial nonsense (an artificially weak yen), though this alternate argument deserves to be read nonetheless:

In most of the world in the past week, attention has been on highly leveraged hedge funds that have been forced to dump assets bought on margin. In Japan, however, a different species of margin trader has—until now, at least—stood firm: the housewife. On her shoulders may lie responsibility for some of the stability of the global financial system.

On August 15th the Japanese currency climbed to a 4½-month high against the dollar and continued to surge against the New Zealand dollar, raising concerns about the sustainability of the carry trade, through which investors borrow in cheap yen to buy higher-yielding assets elsewhere. This had made fortunes for international investors but, lately, Japanese retail investors had become the carry trade's greatest enthusiasts. The metaphorical Mr and Mrs Watanabe account for around 30% of the foreign-exchange market in Tokyo by value and volume of transactions, according to currency traders, double the share of a year ago. Meanwhile, the size of the retail market has more than doubled to about $15 billion a day.

One reason for the surge is margin trading. Brokers are offering leverage of as much as 200 times the down-payment (though the average is more like 20 to 40 times). In July Japanese retail investors' short positions on the yen (a bet that it would fall) exceeded the amount taken by traders on the Chicago Mercantile Exchange, a foreign-exchange trading hub. “The gnomes of Zurich were accused in their day of destabilising markets. The housewives of Tokyo are apparently acting to stabilise them,” boasted Kiyohiko Nishimura, a Bank of Japan board member, in July.

Strikingly, as the yen appreciated, retail traders, rather than dump their positions, saw a buying opportunity and sold yen for other currencies, softening its rise. “The Japanese government has not intervened—they've not had to, because the Watanabe-sans have been selling yen for them,” says James Gow of FXOnline Japan, a retail broker.

However, many institutions are unwinding their carry trades. In the last week alone, the yen has risen 10% against the New Zealand dollar. The fear is that, as investors buy yen, the losses for the remaining carry traders will balloon. If retail investors, too, lose faith, it could set off a stampede that would further disrupt global markets.

On the other hand, there may still be grounds for the carry trade to continue. Compared with other countries, the interest-rate differential remains attractive. Given the global credit turmoil, it is also looking less likely that the Bank of Japan will raise rates to 0.75% from 0.5% at its meeting on August 23rd [it didn't happen]. Whatever happens, Mrs Watanabe is on guard.

Meanwhile, the New York Times has another article on why "Japanese housewives are sweating in secret as markets reel." From a gender equality standpoint, it's a bit sad to note that gender bias and limited career opportunities for Japanese women may have played a role in driving Japanese housewives to engage in this undoubtedly risky business. If you play with fire...

Since the credit crisis started shaking the world financial markets this summer, many professional traders have taken big losses. Another, less likely group of investors has, too: middle-class Japanese homemakers who moonlight as amateur currency speculators.

Ms. Itoh is one of them. Ms. Itoh, a homemaker in the central city of Nagoya, did not want her full name used because her husband still does not know. After cleaning the dinner dishes, she would spend her evenings buying and selling British pounds and Australian dollars.

When the turmoil struck the currency markets last month, Ms. Itoh spent a sleepless week as market losses wiped out her holdings. She lost nearly all her family’s $100,000 in savings.

“I wanted to add to our savings, but instead I got in over my head,” Ms. Itoh, 36, said.

Tens of thousands of married Japanese women ventured into online currency trading in the last year and a half, playing the markets between household chores or after tucking the children into bed. While the overwhelmingly male world of traders and investors here mocked them as kimono-clad “Mrs. Watanabes,” these women collectively emerged as a powerful force, using Japan’s vast wealth to sway prices and confound economists.

Many bought and sold stakes worth into the millions of dollars through margin trading, a potentially lucrative but risky form of trading that uses borrowed money.

Until the credit crisis, which began with troubles in the American mortgage market, the value of foreign currencies traded online by private Japanese citizens, including women, averaged $9.1 billion a day — almost a fifth of all foreign exchange trading worldwide during trading hours in Tokyo, said Kazuhiro Shirakura, an analyst at the Yano Research Institute in Tokyo.

Now Japan’s homemaker-traders may become yet another casualty of the shakeout hitting the debt, credit and stock markets worldwide. If so, these married women could lose more than just an investment opportunity. They could also lose the newfound economic freedom that drew many to currency trading in the first place.

Most analysts estimate that Japanese online investors lost $2.5 billion trading currency last month. In fact, the subprime-mortgage crisis was the first severe market downturn since online trading took off here. Economists see the current tumult as the first real test of Japan’s homemaker-traders, and whether these newcomers have the stomach to ride out markets in a time of volatility.

“Mrs. Watanabe got burned this time,” said Masafumi Yamamoto, currency economist at Nikko Citigroup in Tokyo. “The question now is whether she can make a comeback.”

Indeed, online currency trading has become a phenomenon here, with a subculture of blogs, books and investing clubs for Japan’s legions of housewife-traders. The appeal, many of these women say, lies partly in the potential that online trading offered at least some financial independence for wives who still wanted to dutifully spend their days at home.

Some of the women used their own money, some used their husband’s, and some used a combination of both. But by trading, they challenged deeply held social prohibitions in Japan against money, which is often seen here as dirty, especially when earned through market speculation.

“There are strict taboos against money that isn’t earned with sweat from the brow,” said Mayumi Torii, a 41-year-old mother of one who said she earned $150,000 since she started margin trading in currencies early last year.

Ms. Torii is one of Japan’s most famous housewife-traders. She has written a book on her investing strategies and founded a support group for home traders, the FX Beauties Club, which now has 40 members. (FX is financial shorthand for “foreign exchange.”)

But until her book was released in July, she said, she was afraid to admit even to her friends that she was trading, though her husband knew and approved. Now she is a regular guest on television programs.

Ms. Torii said she intended to keep trading, despite the recent market setbacks. She said it was her best chance to “stand on my own economically,” a necessity she discovered after her first marriage ended in divorce, and she and her son had to live off her meager savings. “I never want to feel that vulnerable again,” said Ms. Torii, now remarried.

For other women, trading offered a more modest sort of independence, giving them a chance to build up savings separate from their husbands’ accounts.

One reason Japan’s homemakers can move markets is that they hold the purse strings of the nation’s $12.5 trillion in household savings [it's now more like $13.5T.] For more than a decade, that money languished in banks here at low interest rates. But as the rapid aging of Japan’s population has brought anxiety about the future, households are starting to move more of it overseas in search of higher returns.

A tiny fraction of this has flowed into risky investments like online currency accounts. Most of these accounts involve margin trading, in which investors place a cash deposit with a brokerage that allows them to borrow up to 20 or even 100 times their holdings for trading.

The practice has been popular not only because it vastly raises the level of potential profits, but also because it allowed wives to trade at home, said Hiroshi Takao, chief operating officer of TokyoForex, an online trading firm.

The housewife-traders were so secretive that many market analysts did not realize how widespread the trend had become until this summer, when the police arrested a Tokyo housewife accused of failing to pay $1.1 million in taxes on her foreign exchange earnings.

While day trading of stocks has also taken off in Japan, the women say they prefer currencies because of the relative simplicity: currencies might involve only a handful of nations, while trading stocks might mean keeping an eye on hundreds of companies.

For a time, margin trading seemed like a surefire way to make money, as the yen moved only downward against the dollar and other currencies. But last month, in the midst of the credit turmoil, the yen soared as hedge funds and traders panicked.

Ms. Itoh recalled that she had wanted to cry as she watched the yen jump as much as 5 percent in value in a single day, Aug. 16.

“But I had to keep a poker face, because my husband was sitting behind me,” Ms. Itoh said.

She did not sell her position, thinking the yen would fall again. But by the next morning, only $1,000 remained in her account, she said.

Yayoi Kawakage, a 40-year-old homemaker who works part time at a real estate consulting firm, said she limited her losses last month to $500 because she sold her positions quickly. She said that if markets become less predictable now, many housewives would likely abandon trading.

“The subprime problem showed good things don’t last forever,” she said.

Still, some analysts point out that the $2.5 billion that Japanese individuals lost last month was just a fraction of a percent of the nation’s overall household savings.

“It is about the same as what Japan spends in two weeks on horse racing, lotteries and pachinko,” said Tohru Sasaki, chief foreign exchange strategist at JPMorgan Chase Bank, referring to a pinball-like game popular among gamblers here.

Mr. Sasaki said he believed the losses were not big enough to scare away married women and other investors. And while the trading volume is far below last month’s, recent data show signs of a return to online trading, said Mr. Yamamoto of Citigroup.

Indeed, most of the half dozen homemaker-traders interviewed for this article said they were already trading again, and the rest said they soon would be — including Ms. Itoh, who said she would probably invest her remaining $1,000 in savings.

“There’s no other way to make money so quickly,” she said.