Ruh-Roh, Raggy!

Submitted by Rich Toscano on July 4, 2006 - 3:41pm

...is how Scooby-Doo might react upon reading about an impending rate hike by the Bank of Japan. Assuming, that is, that Scooby took an interest in global liquidity conditions instead of just constantly getting high.

Rampant E-Z mortgage lending during the first year-and-a-half of Fed tightening posed a seeming puzzle. But the answer to the puzzle lay outside our borders: in this age of globalized capital markets, tightness by one central bank could be offset by looseness of another. And they don't come any looser than that Bank of Japan. The BOJ's ultra-low rate policy made it easy for financiers to borrow in Japan, lend to US homebuyers, and pocket the interest rate differential. It also encouraged yield-starved Japanese to lend their own money in a similar manner.

That strategy works great until you realize the American homeowner won't be paying you back. Or, until Japanese rates start to rise.

A wee hike by the BOJ won't change the fact that there is still a huge spread between Japanese and US rates. The point is that the trend may soon start to head in the other direction. 2005 taught us that when it comes to mortgage lending, global liquidity is what matters. And Japan has been one of the biggest providers thereof.

But with the ongoing removal of quantitivate easing, and now with this potential rate hike, it seems that the Japanese are serious about tightening things up. If they keep it up, it might not be so E-Z to offer up all that E-Z Credit.

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Submitted by powayseller on July 4, 2006 - 4:23pm.

It seems pretty likely the BOJ will raise rates, but some in the government are opposed to a rate hike.

The $300 billion yen carry trade should be unwound by now, and I wonder what the effects of that have been? The BOJ called in $300 billion which had been lent at 0% interest, and this was returned to them between March 30 and June 30, 2006. I thought this would raise long-term bond yields.

Submitted by LA_Renter on July 4, 2006 - 4:49pm.

Here is a look at the 10 yr bond during that time, it looks like the yields have definitely gone up.

http://finance.yahoo.com/q/bc?s=%5ETNX&t=6m

As I recall last year, the FED was raising in 1/4 point increments through the year and the long term bond yields fell, primarily due to the effects of the carry trade. That aint happening this year.

Submitted by powayseller on July 4, 2006 - 5:10pm.

The 10 year bond was 4.5% in June 04, and just broke that barrier in January 06. That was a long time to not break past 4.5%, despite the regular Fed rate hikes. In the first 4 months of this year, the yield went up to about 5.2%, and has been flat since.

How did the March 30 - June 30 elimination of $300 Bil (part of that from the 10 year or 30 year bond market) affect the 10 year bond? I don't see any pattern during that time period. The yield broke its uptrend in mid-May.

Thanks for the link. Can you help me understand this?

Submitted by LA_Renter on July 4, 2006 - 8:26pm.

Here is my general understanding of this. The reason the 10 yr bond did not budge from June 04 to Jan 06 is a result of the carry trade itself. With no cost to the yen and billions being flooded into the Japanese economy traders took that money and put it into one of the safest places they could think of US Treasuries especially as the FED was tightening. IMO this caught the FED off guard, they saw that housing was over heating as a result of keeping interest rates too low too long and thought the long bond would go up as they tightened therefore cooling the housing market. But instead of the long bond going up it attracted billions in foreign money holding yields artificially low. This miscalculation will prove to be devastating. Look at the appreciation in the bubble markets in 2005 as a result of this. The break out in the yields from 4.5 to 5.2 during the first 4 months of the year was IMO a result of Japan announcing the end of quantitative easing. Traders trade based on the future not the present that’s why it does not correspond March 30 to June 30 time frame. Even with the end of Japan's quantitative easing there is still a large global glut of liquidity out there.

Submitted by sdduuuude on July 7, 2006 - 9:55am.

Some supporting evidence for Rich's bold accusation:

Scooby Doo

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