Stan, since I was the only poster to use the word “insane” in describing those who would buy a 1.5% 5-year Japanese note, I assumed your post was aimed principally at me. Thus, your exposition on the yen-dollar carry trade came across as condescending (to me) much like an explanation that 3×2=6. So, pardon the confusion and the condescension – perhaps it was misplaced.
Having said that, I found baffling your comment: “I’m sure you’ll recall from finance 101 that the yield of a longer term bond is a function of the the shorter term yields. If the short term bond is 0.76%, then the implicit assumption is that the 3-5 year yield is probably 2.5% or 3% if the 5 year is yielding 1.5%, which, though still low and possibly not sufficient for the risk undertaken still may make sense.”
I’m not sure where to begin, so I’ll start with the current (as of yesterday) term structure of Japanese interest rates:
3 Month 0.70%
6 Month 0.74%
1 Year 0.81%
2 Year 1.05%
3 Year 1.18%
4 Year 1.37%
5 Year 1.51%
As you’ll notice, the yields on the 2-4 year notes are between 1.05% and 1.37%, not the 2.5%-3.0% (I think) you suggested. Perhaps more important, this 2.5%-3.0% is not “implied,” as (I think) you suggest. Correct me if I’m wrong, but I think you’re getting confused about “bootstrapping,” which is the process of calculating the implied rate on a theoretical zero-coupon bond by using the actual yields on the shorter-term (coupon) securities that would comprise it. For example, because we know the 6-month rate (0.74%) and the 2-year rate (1.05%), we can do a little algebra (via the “bootstrapping” process) and calculate that if a 2.5 year zero coupon bond existed it would yield about 1.13%. So, while you’re correct for the most part that “yield of a longer term bond is a function of the the shorter term yields,” you’ll have to explain to me what mathematical process gets us to implied rates of 2.5%-3.0% for the “3-5 year yield.” Although, perhaps I’m not understanding you correctly.
(As a side note, I’m a big fan of Nassim Taleb, but he’s another guy – like Jim Grant and many others – that’s very, very smart whom you’d never want managing your money. It’s more than a little ironic that the hedge fund that Taleb ran for several years is basically on life-support at this point because he ran across his own financial “black swan” – market volatility has been unprecedentedly low for an unprecedented period of time, while his fund was set up to lose small bits of money during periods of low volatility but to make big money once volatility returned to “normal” levels. The high vol periods were so infrequent that the fund just kept bleeding over several years until people gave up on him. In other words, the outlying event was an absence of outliers! Talk about irony. I think his consulting practice still does pretty well, however.)
