August 29, 2024 • 38 mins
Remember August 5th? That was the day that markets around the world plunged in historic fashion and everyone became an overnight expert on the yen carry trade. But what really is the yen carry trade? How big is it? Who is making the trade? And what is its connection to markets all around the world? On this episode, recorded at the Kansas City Federal Reserve Bank of Kansas City's Economic Symposium in Jackson Hole, Wyoming, we speak with Hyun Song Shin, economic advisor and head of research at the Bank for International Settlements. He walks us through the mechanics of the trade, what went on in early August, and the lessons we've already learned from it.
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Episode Transcript
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Speaker 1 (00:03):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2 (00:20):
Hello and welcome to another episode of the Odd Thoughts Podcast.
I'm Tracy Alloway.
Speaker 3 (00:25):
And I'm Joe Wisenthal.
Speaker 2 (00:26):
Joe, do you remember the carry trade unwined?
Speaker 3 (00:29):
It was so the carry trade, what's the deal? Basically
people borrow yen and buy and video and then the
yen went up and then the trades didn't work as well.
Speaker 2 (00:37):
Well, that was one aspect of the commentary.
Speaker 3 (00:41):
As like the Twitter version of what's happening?
Speaker 2 (00:43):
Yeah, but I think actually okay, So we are recording
this on August twenty third, the carry trade unwind happened.
What was it two weeks ago? Two or three weeks ago. Yeah,
it feels like a lifetime ago, and it's kind of
remarkable how quickly it failed into the background with the
market rally and the recovery. But the conversation at the
(01:05):
time was that there is this carry trade, which involves
borrowing in lower yielding currencies or lower interest rate currencies
such as the yen, and then investing in higher yielding
assets like in theory, US technology stocks.
Speaker 3 (01:22):
Or you US treasuries.
Speaker 2 (01:23):
Yeah, but the problem is that some of the discourse
around this has been. I've kind of been offended by
some of it. I've seen things out there basically implying
that the entire financial system is imploding because the carry
trade is unwinding.
Speaker 3 (01:38):
I mean, it's really crazy, Like how quickly that disappeared,
because you know, there was that megavol spike and we
were talking like historically high level is on par with
some of the financial crises, and then you know, the
expectation is like, at a minimum, this takes a while
to settle down. Yeah, and it's settled down in about
(01:59):
fifteen minutes, in a day and a half. Absolutely, what
was that? What is the carry trade? Because there is
this sort of caricature version that is out there, who
actually is engaging in it? Is it still going on?
Many questions in my head remain unanswered.
Speaker 2 (02:13):
Yeah, and one of the big ones is just how
big is it actually? And one of the funny things
that happened a few weeks ago is people were basically
looking at all the yen denominated assets in the world,
like the entire Japanese banking system, and saying, this is
the carry trade. This is how big it is.
Speaker 3 (02:29):
Okay, let's clear up some misconceptions.
Speaker 2 (02:32):
We are going to do that right now, and I
am so pleased to say that we do, in fact
have the perfect guest. We are recording here in Jackson, Haw,
Wayoming for the Kansas Fed Economic Symposium, and we have
once again run into one of our favorite all Thoughts guests,
an expert on this exact topic. We're going to be
speaking with Hyun Sung Shin. He is, of course, the
(02:54):
economic advisor and head of research for the Bank for
International Settlements and he's been looking at the carry trade
for years now.
Speaker 3 (03:01):
So Ken he actually knows what he's talking about.
Speaker 2 (03:03):
Yes, Kian, thank you so much for coming on odd lots.
Speaker 4 (03:06):
Thank you for having me again.
Speaker 2 (03:08):
It's so good to see you again. Absolutely beautiful Jackson Hall. Absolutely,
I'm so glad we could make this happen, and that
I am kind of glad that the carry trade unwind
happened just a couple.
Speaker 5 (03:19):
Of weeks ago.
Speaker 3 (03:19):
Something to talk about.
Speaker 2 (03:20):
Yeah, and you happen to be here and you're an
expert on this, So let's start with something very basic.
What is the carry trade?
Speaker 5 (03:28):
The carry trade is a financial transaction where you borrow
a currency with a low interest rate and then investor
proceeds in other higher yielding assets, and I think the
you know, the classical version of a carriage.
Speaker 4 (03:43):
Trade would be where you borrow.
Speaker 5 (03:46):
I mean, it's basically a currency transaction where you borrow
a currency with a low interest rate and invest in
a in a higher interest rate currency. But the way
that the carry trade was portrayed in the recent discussion,
I think that was you know, described in much broader terms,
where you were going into all kinds of different assets
(04:07):
and Joe, as you describe, it was a very short
lived episode of stress, but.
Speaker 4 (04:12):
At the time it was pretty intense.
Speaker 5 (04:14):
Yeah, and you know, I think, you know, we can
now look back on it with some relief that nothing broke.
You know, there was no financial market dysfunction as we
saw during the March twenty twenty episode for example. So
now we're now back to something which looks more normal.
But I think we should try and learn some lessons
from that episode.
Speaker 3 (04:34):
Absolutely, and you know, obviously there's a lot that's still
out there and much to be learned before we even
get to the future. I mean, you described what a
sort of classical carrier trait is and what we're talking about,
and I joked in the beginning, you know, it's like
borrow yen cheaply and then by bitcoin or whatever. But actually,
(04:54):
like when we talk about this, who are the actors involved?
Is it seculators who see a spread? Is it institutions
like insurance companies, etc. That have some sort of like
larger structural reason. Like who actually is engaged in such
type of activities.
Speaker 5 (05:12):
It's really the whole ecosystem, if you like, I think
the main actors would shift from from time to time.
I think one way that we could try and approach
this question is, you know, as Tracy alluded to earlier,
have large is this you know, what's the most reliable
way of trying to gauge this? Now, one way of
doing that is to look at the on balance sheet
(05:33):
lending in yend and at.
Speaker 4 (05:35):
The BIS is.
Speaker 5 (05:36):
You know, we receive data from our member central banks.
We collected and then we distributed, and we've been doing
it since nineteen seventy seven, so in a way we
are the curators of this very important banking data of
international banking business. So one thing that we can look
at in that data set would be what is the
(05:56):
cross border lending that is yen denominated, or even if
it's not cross border, what is the en denominated lending
as a foreign currency, so you know, even if the
loan is booked in a country outside Japan, it's it's
in yen, and it's it's in foreign currency. Now, one
of the things that I put in a tweet thread
is that if you look at that that number, there
(06:19):
was clearly a very sharp increase in yen borrowing as
foreign currency in twenty two to twenty three. But it's
something like forty trillion yen, So you know, that's quite large,
you know, two hundred and seventy billion dollars roughly depending
on exchange rate, But it's not the kind of numbers
(06:40):
that were being banded about in the markets, and not
all of that is going to be you know, engaged
in yen carry trade. The other way of you know,
thinking about this how is how does that borrowing take place?
And one thing that is quite interesting is that a
lot of the cross border lending is happening through the
interoffice accounts, which is to say, if there's a foreign
(07:00):
banking group which has an office in Japan, how much
is the subsidiary or the office in Japan lending out
to the headquarters in Yen. And that turns out to
be a preciseable chunk of that. Of that forty trillion,
it's around fourteen trillion would be you know that that interoffice.
But much more important than this on balance sheet is
(07:22):
the off balance sheet transactions. And here the crucial market
is the FX swap market. And FX swaps are where
you know, one party would deliver one currency. So if
I deliver dollars to the counterparty, counterparty.
Speaker 4 (07:39):
Would give me the equivalent in yen.
Speaker 5 (07:42):
With the promise that that transaction would be reversed at
a set date in the future at an agreed exchange rate.
So the exchange rate is fixed at that point. And normally,
if I'm a dollar provider, what I do is I
provide the dollars, I receive the yen in return, But
because I need to repay the yen, I need to
keep it in a safe place, so I would park
(08:04):
it in a safe in a yen asset.
Speaker 2 (08:07):
Just to be clear, Typically FX swaps it's it's not
really a trade per se, or it's not often a trade.
It's more of a hedging activity. So if I have
a lot of yen exposure, I want to offset some
of that by acquiring dollars and vice versa.
Speaker 5 (08:20):
Yeah, and that's exactly the classical the use case for
a for a swap contract. But the but the issue
here is if I receive the yen rather than parking
it in a safe place, what if I just sell
that yen on the spot market and acquire dollars, Then
I have a naked yen obligation which I will need
to meet at the time by repurchasing the yen on
(08:43):
the spot market. And that market is pretty sizeable. It's
around fourteen trillion dollars the swap market between yen and
another currency.
Speaker 4 (08:53):
That's you know, that's.
Speaker 5 (08:55):
Quite a bit larger than the two hundred and seventy
billion that I mentioned earlier.
Speaker 3 (09:00):
Just so as Tracy characterized it, there is sort of
a natural hedging need for those sort of swaps. What
types of institutions have that need to engage in the
slot market.
Speaker 5 (09:13):
It's both financial and non financial. I think typically the
textbook case is of a non financial institution. So, you know,
if I am an exporter or an importer, you know,
I would like to pay for you know, the goods
in advance, but then I need to hedge the currency
exposure in the meantime until the you know, the maturity
(09:36):
of that swap. What we've seen though, is that since
the global financial crisis, it's the financial uses of the
FX swap market which has really grown much larger. So
it's fair to say that it's the financial uses of
the FX swaps which are the line share of the
of the FX swap market. And I think it raises
(09:59):
perhaps a deeper question, which is, if you're not constrained
by the funding currency in what you can invest in
by using the swap market. In other words, suppose I
can only raise funding in one currency. Well, typically that
means that, you know, unless you have balance sheet mismatches,
you would need to invest mostly in that same currency.
(10:22):
But through the swap market, you can basically overcome you know,
that particular constraint. And what that means is it's much
better to think of financial conditions in global terms rather
than simply country by country, because you can you can always,
you know, deploy the funding in one currency and invest
(10:42):
in the assets of another currency.
Speaker 2 (11:00):
It sounds also like it's additional liquidity if you can
use FX swaps to bypass you know, specific currency constraints
in terms of funding capacity. If I was I don't
know an emerging market like exporter, and I needed dollar funds.
Obviously there's a limit to the amount of dollars that
(11:21):
I can get in a situation like that. But if
I know that I can go into the FX swap
market and get that additional liquidity, it presumably expands credit
in the overall system.
Speaker 5 (11:31):
In contractual terms, a swap is completely symmetric because you
know one party is providing one currency in return for
the other and vice versa for the other party. But
from time to time, when financial conditions vary across different currencies,
different markets, there is a if you like a lead
party in asking for that transaction, and you know there
(11:54):
is a market if you like response in supplying it.
So let me give you an example. So if I
am a let's say I'm a Euro area insurance company,
and I would like a globally diversified portfolio including dollar assets.
But most of my obligations are in euros, and so
if I were to invest, you know, nakedly in dollars,
(12:15):
there would be a currency you know, there'll be a
currency mismatch on my balance sheet. And this is where
I would go to the swap market. I would swap
the euros into dollars and that I would invest the
proceeds into dollar ponds, for example, in a way that's
like borrowing dollars. I mean, the economic rationale is very
similar to borrowing dollars in order to invest, but it's
(12:37):
not treated as borrowing in the conventional accounting sets because
you know it's a swap. There is also a countervailing,
you know, a transaction the other way, but you can
normally track what's called an EFFC swap basis to see
which direction that transaction is going. So it turns out
that typically normally it is more expensive to borrow dollars
(12:59):
in the swap market then it is to borrow dollars
in the dollar money market. And that extra premium is
if you like the additional price you have to pay
in order to access dollars. Now coming back to the
yen story, although most of the time, you know, financial
institutions are borrowing dollars in the swap market in order
(13:20):
to invest in dollar acidence, that's typically the direction of
the trade. This is why you know during financial stress periods,
you know these effects swap bases, you know spike and
then there has to be central bank swap lines to
quill et cetera. But there's nothing in principle that says
it always has to go towards a dollar, right if
(13:40):
your intention is to engage in a yen carry trade,
but through using EFFCS swaps, you know, you could borrow
yen and then you know, acquire that en obligation by
going through the swap. And so one telltale sign is
what happened to the effects swap basis during this recent episode.
And in fact, one of the interesting findings is that
(14:02):
the dollar effects basis versus the yen you know, hardly budged.
It's actually, you know, a very small movement, which is
very atypical of a financial stress event.
Speaker 2 (14:12):
Yeah, how did Why is that? Because I would have
assumed that the people providing swaps, who I assume are
dealer banks of some sort, with such volatility in the
currency rate, I would have thought that they would back
away from providing that liquidity and so the basis would
blow out.
Speaker 5 (14:31):
So there was definitely a little bit of that, but
it was by no means the same magnitude as we saw,
for example, in the March twenty twenty episode. And the
reasoning would be that in that case, the if you like.
The party that was driving that particular transaction wasn't borrowing dollars,
which needed to be you know, repaid in this scramble
(14:53):
for dollars, but rather it was the you know, repayment
of yen. Oh I see, okay, so it goes the
other way.
Speaker 3 (14:59):
So, you know, so much sort of happened during that
I don't know, there's sort of like the mini crisis
of July thirty first to August sixth of twenty twenty four,
and it came in went.
Speaker 2 (15:12):
That should be the official name.
Speaker 3 (15:13):
Yeah, that's a name of that. So you know, there
was a FED meeting that perceived perhaps to be a
little hawkers. Then we got a week unemployment report. Then
of course, you know, the end had been creeping up
right now, and you know, we'll probably still be learning more.
What is the story that you tell, like what actually
happened in those six or seven days that triggered such
(15:34):
a move and then triggered such a move that was
able to reverse so easily. What you're basic what happened
that week?
Speaker 5 (15:39):
Yeah, and clearly, Joe, there was quite a bit of
action in the currency markets. But I think what you're
referring to is the fact that equity markets were you know,
impacted very broadly across the world in a way that
you wouldn't have expected if it were a sort of
narrow carriy trait story. And indeed, I think there is
something to that in the probably we're we're putting too
(16:02):
much weight on the carriage trade as a key theme
of what happened in early August. In that yes, I
mean there may have been the classical carriage traits going
on where you borrow yen and then you invest in
the high yielding currencies. You can see which currencies fell
most in early August, and they were the Mexican peso,
(16:26):
Columbian peso, and the rand. So these, you know, these
were the destination currencies for those classical carriage trades. But
I think it's it's not really enough to explain why
there was this much more broad based stress, especially in
the in the equity markets. And I think here we
have to think about the broad issues to do with
(16:46):
how you know risk is managed, how you know risk
management itself.
Speaker 4 (16:51):
Risk management in.
Speaker 5 (16:52):
The form of loss mitigation also generates some potential for
amplification that could actually you know, make things you know
more volatile. So let me explain what I mean by that. So,
if I have a value at risk rule that says,
you know, if my risk is triggered beyond this this
var level, then I cut my position. That means I sell,
(17:15):
or if I'm lending, I cut my lines, et cetera.
From the point of view of the borrower or from
the point of view of the of the market as
a whole. You know, that is something that would actually
you know, amplify, you know, whatever stress that was there
in the first place. If I'm a lender and I
set margins, or if I'm a CECP, a central counterparty
(17:36):
or an exchange, you know, there is a margin that
I ask for, you know, the various contracts that I
deal with. Typically during stress periods, those margins go up.
So that's kind of deleveraging. Now, the way that we
deal with risk is precisely to mitigate loss, and there
is this you know, spillover effect that goes to the
broader market. And I wonder whether we should you know,
(17:58):
look back on the events of early August and if
you like, apply that lens to you know, to the
events back then. So if you know, for example, I
was not you know, borrowing in and investing in technology
stocks as you as you suggested, But it's just that
you know, you know, within my firm, you know, there
(18:20):
is a team that is doing a classical carrier trade,
but there is also a team that is you know,
leveraged the US tech stocks. But one team doesn't know
what the other team is doing. So let's say, you know,
one pod doesn't know what the other pod is doing.
Speaker 4 (18:33):
But from the.
Speaker 5 (18:33):
Firm's point of view, it looks as if you know
in aggregate that you know there is a short end
position and the long position in technology stocks, and if
that you know, risk constraint is triggered somehow, it's going
to have a much broader implication, much broader repercussion through
all of the wholdings.
Speaker 2 (18:52):
This kind of reminds me there used to be that
saying about in a crisis, you sell what you can,
not necessarily what's most impact. Did So it might be
that the most volatility is falling in the currency market
and in the carry trade, but the thing that you're
selling to reduce your risk exposure is something totally different.
Just because you can, or because it's easier to do
(19:14):
in an extremely volatile environment, and if you.
Speaker 5 (19:18):
Like, it's the it's the risk limits that are triggered.
And the way that risk limits work is if the
aggregate portfolio is suffering losses, then the risk limits are
tightened for all the different you know, different assett that
you own. And I think, you know, there is I
think something that we need to think about in terms
of how we can mitigate some.
Speaker 4 (19:37):
Of these some of these issues.
Speaker 5 (19:38):
And going back to the the FX swap discussion, the
BIS also collects data on FX swaps. You know, we
have the six monthly release of our over the counter
derivative statistics and the numbers that I've given you you know,
either all from from our data, it's all on our
web page. I think there is probably more scope for
us to have more refect fine data. For example, you know,
(20:02):
who is the instigator in having the effects well, you
know drawn up in the first place, So who is
the lead party, where is it being booked? What are
the sectors that the two parties are coming from. At
the moment, we don't have that kind of data, but
this is something that the BIS is working very hard
to try and assemble. And given the shift away from
(20:24):
the very bank centric system to something which is much
more a market based system which we have now. I
think this is really, you know, something that we need
to do as a matter of vergency.
Speaker 3 (20:49):
So can we actually, I want to go back to
your point about, you know, financial conditions being a global phenomenon,
because that has been one of the questions here in
the US, and there are people scratching their heads financial
conditions by some measures being tight, but spreads being very
narrow for credit and of course the stock market having
rocketed up. Can you flesh that out a little bit
(21:11):
more like this sort of like how we should rethink
financial conditions in a world of sort of like easy
swapping between currencies on a non bank basis.
Speaker 5 (21:20):
Sure, sure, I mean that's a very very important issue, actually, Joe.
You know, when you look at the typical financial conditions index,
let's say, you know, you take the Golden SAX index,
which is probably the best known. There are two components there.
One is really just about how high our interest rates,
how high a yields. There's another set of indicators which
measure how tight are the credit spreads? You know, what's
(21:41):
the dollar doing that kind of thing. And what's really
been quite surprising is that even though rates have been
raised to quite high levels. So the rates, those indicators
that point to how our interest rates are they've been
quite tight. But stock markets, credit spreads, you know, they've
been extremely accommodated.
Speaker 4 (22:02):
And I think one way that.
Speaker 5 (22:03):
You know, we could rationalize this is that, you know,
if we have a world where essentially money is fungible
across currencies, basically what swap does is to make money
fungible across currencies. You know, five dollars I can get
you know, yen vice versa. And in that kind of environment,
(22:24):
it's not simply how much the US money supply is,
how much you know, the Euro money supply is that matters.
Speaker 4 (22:34):
It's really about what the global picture is.
Speaker 5 (22:37):
And what are the marginal rates at which one is
swapped into the other. And I think one potential explanation
for why financial conditions have been, you know, so accommodative
in spite of the very high rates is that, you know,
money will flow to the most accompetentive section of the
money market, and the swap is the instrument that's going
to really you know, give you that fungibility. And when
(23:00):
we look at the growth of the aggregates, it's been,
you know, it's been quite rapid. So if we go
back to the GFC. Before the GFC, the global financial
system it was very much a bank based system, and
the GFC was you know, in essence of banking crisis,
and the existing BIS banking statistics covered that really well.
(23:21):
You know, in some of my work as an academic,
you know, I relied really a lot on the BIS
banking data to really you know, document what happened in
the lead up to and then the resolution. But since
the GFC, we've moved very much to a market based
system where the non bank financial intermediaries are taking on
(23:43):
a much bigger role. And in that world, the banking
statistics that the BIS puts out is only looking at
a very small part of the overall universe, and increasingly
it's the EFS, swap market and other market based intermediation
figures that we need to keep track of. And so
(24:03):
in that sense, it's quite important for us to update
our perspective on how markets work, what kinds of indicators
we need to keep track of, and basically make sure
that the official statistics are really up to scratch.
Speaker 2 (24:18):
So in the two or three weeks since the carry
trade hit the headlines, the yen dollar exchange rate has
normalized somewhat. But if you had to, if you had
to take an educated guess, how does the carry trade
re establish itself or how does it evolve from here?
Because I have to imagine there's some lingering memory, even
(24:40):
if it feels like a lifetime ago, that this actually
happened on the market. So what happens next in terms
of the carry trades evolution?
Speaker 5 (24:49):
Well, actually, I think you know, you've had guests on
on odd lots where one of their big themes was,
you know, we're waiting for this big crash because it's
going to present a huge opportunity for us to come
and really pick up some bargains. And you know, if
you were following this and you had spare powder on
August fifth, for example, that was the Monday, then there
(25:10):
were huge opportunities out there. I mean, you know, think
about the Vics. The Vics hit sixty five on the
morning of August fifth. So I think we have to
assume that many of the people who are very who
are very you know, agile, are already back in And
I think what we need to think about is, well,
first of all, we have to you know, we have
(25:32):
to be thankful that nothing broke, But at the same time,
you know, you know, we can't be complacent and say, well,
that's it, we can forget about it. I think we
have to learn some lessons from that episode, and one
of those lessons is some of the standard ways I've
been looking at markets may not be adequate. We have
to look at some of these bigger pictures ues, especially
(25:52):
those big aggregates that have been off the radar for
various reasons, and we have to bring them back on
the radar. And I think when we think about, you know,
the broader policy questions as well, especially in monetary policy,
financial conditions are absolutely key. They're a key input into
how we conduct monetary policy. And so even for that question,
(26:13):
how will financial conditions involve, we have to think about
this big a picture.
Speaker 3 (26:17):
Thinking back to that week. From a sort of fundamentals standpoint,
there was nothing that major that had happened, you know,
like I think maybe the unemployment rate cod people will
buy surprise, but data is noisy and there are surprises
all the time in both directions. Maybe the FED, I
don't know, the Bank of Japan, obviously, they're a little
(26:38):
bit out of cycle, perhaps with other central banks. I
think actually today we got a two point seven percent
inflation reading, so maybe it's all higher, but there was
nothing like that unexpected. Think about like risks going forward,
the fact that you could have such a sharp move
in such a short term. What does that say generally
about the broader I don't know, structure of the financial system.
(27:00):
And nothing broke and it did quiet down extraordinarily fast,
But what does it say about the structure of the
financial system or broadly that's something that sharp can happen
without some seemingly you know, major fundamental surprise.
Speaker 5 (27:13):
And you're absolutely right. So the fundamental economic news was
not you know, that bigger surprise. I mean, there were
some surprises at the margin, but nothing major. I think
what it does point to is the power of amplification
effects of various sorts. Yeah, and you know, as officials,
you know, as policymakers, we need to think about how
(27:34):
do we dampen those amplification effects in a way that's
going to you know, preserve financial stability and not have
one of these episodes feed into the real economy. And
you know, the typical response we would go to would
be something like regulation. If these were banks, you know,
that would be the sort of in the first port
of call. But because if these are non banks, some
(27:56):
of them, many of them are not regulated, that's not
really you know, the first port of call. But you know,
there are points of contact with a regulated financial sector
where we can do something. I think one of the
things that one of the lessons we learned during March
twenty twenty, you know, with the treasury market, you know stress,
was that we need to make sure that we don't
(28:16):
have these hugely pro cyclical margin you know variation that
means that there are four sellers onto the market. Now
you know these huge swings are justified. Well, you know,
some people were justified saying, look, I need to protect
my solvency by you know, raising the margins. But that
has huge repercussions for the others. So from a systemic perspective,
(28:39):
you know, that has negative spillover effects. So that's one
example where if we can make sure that margins are
margins don't get eroded too thinly during good time so
that you know, they're raised very sharply, that's that's really
a no brainer, and that's something that the official sector
has worked on we actually, of course, need to have
much better data on these other aggregates that you know,
(29:03):
have now emerged as being very very important, and the
BIS is on that is on that case, you know,
we are working very hard to make it much more
detail so that it's going to be much more useful.
But it's going to be a continual, you know, struggle, Joe,
because you can never declare victory because you know, the
financial system is always evolving and you're just you know,
(29:23):
you're playing catch up all the time. It's just a
case of how badly behind are you, you know, with
the realities.
Speaker 2 (29:31):
I have just one more question, which is thinking back
to August fifth, when markets were tanking, there were, or
at least there was one prominent call for one hundred
basis point emergency rate cut. And I really don't mean
to be mean spirited here, because you know, hindsight is
(29:53):
twenty twenty and we all get things wrong from time
to time. But I'm just very curious we're here at
Jackson Hall with a number of high profile policy makers.
Is there any discussion of that call or any like.
Are people talking about how ridiculous maybe that that call
actually was at the time The idea that the FED
(30:16):
was going to cut rates one hundred bases points, and
now to two or three weeks later, we have markets
near all time highs, the FX exchange rate has normalized
to some degree, and a lot of this is just
in the rear view mirror.
Speaker 5 (30:31):
I think we have to look at this with a
bit more sympathy, Tracy. I don't think we can say
definitively yes or no. You know, if we think back
to the summer of nineteen ninety eight when LTCM Long
Term Capital Management hedge fund failed, there was tremendous stress there,
and you know, there was an intermeding cut at that
(30:52):
point because what you know, we could see then was
that the real economy looked to be, you know, showing
signs of being affected. And similarly, I think with March
twenty twenty, you know that was a treasury market. Clearly
fixed income is much more closely tied with the real economy.
So I would never say never, But you know, if
(31:14):
it's so, what are we looking at in deciding whether
you would go in and to intervene, Well, you're looking
for signs of complete dysfunction in the market, where the
market is just broken down and nothing is you know,
being sold or bought, and this means that the flow
of finance to real economic activity is really suffering. I
think if you see signs of that, then I think,
(31:36):
you know, there is a stronger argument for an extraordinary intervention.
But as you say, I think, you know, looking back,
although it was a pretty you know, intense period, those
two days in retrospect, wasn't the kind of thing that
needed extraordinary intervention.
Speaker 3 (31:52):
I just have one last question, and I guess it's
sort of broad, but it's also one that I think
some of our listeners are curious about, and I'm so
I'm curious about from the BIS perspective, Like people are
always very interested in the idea of like speculative excess bubbles,
et cetera. I'm curious from the BIS perspective, do we
(32:13):
have reliable measures that can observe that. Do we have
you know, you could feel it in the error sometimes
people are talking about AI or whatever it is at
any given time, But do we have good tools to
quantify sort of the level of what we'd call speculation
in the market and at any given time.
Speaker 5 (32:32):
We always have good measures when in retrospect, so we
can always look back to the previous crisis. Yeah, so,
oh wow, we should have taken notice of that. So,
you know, if we go back to the GFC, it
was a growth rate of credit, it was growth rate
of cross border lending and in particular the growth rate
of crossborder lending and dollars, which was you know, making
(32:55):
this round trip from the US to Europe back to
the US. And what tends to happen. And I think
the BIS, like any other efficiency institution, is guilty to
some extent, is that, you know, we draw up a
checklist and say, well, next time, let's not ignore A,
B and C, and let's have a list that we
(33:16):
check and of course, you know, we have this accumulated
checklist that we take along with us we as we
experience market. But it's never going to be adequate, right,
So this time around, what happened was not really you know,
central to some of our checklists. So, you know, I think,
to be fair, I think the BIS is probably the
(33:38):
best place to draw up.
Speaker 4 (33:41):
A checklist that is closest to you know, what's going on.
Speaker 5 (33:45):
You know, we are pretty close to the ground and
in following these things, and we have very good data.
But it's something that needs constant effort. Right, It's like
it's not something that just comes easily and it's simply
a matter of you know, effortless, you know brilliant that
gives you that it's something that always needs effort. We
have to keep you know, we have to keep studying,
(34:05):
we have to keep looking, and so it's going to
be a never ending struggle.
Speaker 2 (34:10):
All right, Well we both look forward to the BIS
bubble index that you will inevitably be building. But h
thank you so much for coming back on All Loots.
Speaker 5 (34:18):
That was amazing, Yeah, fantastic, Thanks for inviting me back,
because yeah, great conversation, Joe.
Speaker 2 (34:38):
I'm so glad that we could catch up with him
and that he was basically our first episode on the
carry trade.
Speaker 3 (34:44):
I love I love talking to Hugh and it's always
just like incredibly illuminating and pleasant and great, many interesting
things there. I mean, for one, I sort of appreciated
him just explaining what the carry trade is, that different
types of actors, whether you're an import or export, or
why you would want to engage in it. Like again,
just I don't know misinformation is the right word, but
(35:06):
the amount of people who want to appine on something
like this for the first of the people who actually
have some insight is a there's quite a gap.
Speaker 2 (35:14):
Well, I do think the nuance on causality is kind
of important there, So the idea that okay, two things
kind of happened at the same time, which is the
carry trade unwound and US stock sold off, But that
doesn't necessarily mean that one thing is directly causing the other.
Speaker 3 (35:31):
Right, And it gets to like the joke every time
you know, there's some big market event and someone goes, oh,
pod blew up. But it's sort of like that, which
is basically it really if there is some volatility, if
you're losing money, it doesn't really matter what strategy you're
using or whether that strategy is central to it. You
sell something right, and so you still have that effect.
Speaker 2 (35:52):
Someone taps you on the shoulder and says, reduce leverage,
So you reduce leverage. The other thing I thought was
really interesting was the idea of the fungibility yes of money.
And I think we've talked about it on the podcast
before and I've certainly mentioned in the newsletter, but I
do feel there is a sense that okay, interest rates
went up in the US, and so credit and dollars
(36:13):
became more expensive, but that doesn't mean that they became
less available.
Speaker 3 (36:18):
Yeah. No, that's such a fascinating idea, and the idea
of like a global the need for a global financial
Conditions Index or something like that. And if you're just
looking at the US in isolation, there are things that
don't seem to make total sense in terms of especially
the disconnect between what happens with rates and what happened
(36:38):
with spreads over the last couple of years. But that
perhaps if you sort of aggregate everything together and recognize
that any there are multiple places to get funding or
get liquidity, maybe some of these puzzle pieces fit together
a bit more.
Speaker 5 (36:52):
Yeah.
Speaker 2 (36:52):
So I'm looking forward to the Global Financial Conditions Index
and the Bubble Index.
Speaker 3 (36:56):
Yes, many many indexes for the BIS to get out.
But if there's any entity that I feel confident could
do it, it'd be Hun in his team.
Speaker 2 (37:04):
All right, shall we leave it there?
Speaker 3 (37:05):
Let's leave it there.
Speaker 2 (37:06):
This has been another episode of the Odd Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway
and I'm Joe Wisenthal.
Speaker 3 (37:13):
You can follow me at The Stalwart follow Hun Song Shin.
He's at hun song Shin, follow our producers Kerman Rodriguez
at Kerman Ermann, desh Ol Bennett at Dashbot, and Kilbrooks
at Kilbrooks. Thank you to our producer Moses Ondem. For
more odd Lots content, go to Bloomberg dot com slash
od Lots, where you have transcripts, a blog, and a
newsletter and you can chat about all of these topics
twenty four to seven in our discord discord dot gg
(37:36):
slash od Lots.
Speaker 2 (37:37):
And if you enjoy odd Lots, if you like it
when we talk to Hume, then please leave us a
positive review on your favorite podcast platform. And remember, if
you are a Bloomberg subscriber, you can listen to all
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order to do that, just find the Bloomberg channel on
Apple Podcasts and follow the instructions there. Thanks for listening
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2 (00:20):
Hello and welcome to another episode of the Odd Thoughts Podcast.
I'm Tracy Alloway.
Speaker 3 (00:25):
And I'm Joe Wisenthal.
Speaker 2 (00:26):
Joe, do you remember the carry trade unwined?
Speaker 3 (00:29):
It was so the carry trade, what's the deal? Basically
people borrow yen and buy and video and then the
yen went up and then the trades didn't work as well.
Speaker 2 (00:37):
Well, that was one aspect of the commentary.
Speaker 3 (00:41):
As like the Twitter version of what's happening?
Speaker 2 (00:43):
Yeah, but I think actually okay, So we are recording
this on August twenty third, the carry trade unwind happened.
What was it two weeks ago? Two or three weeks ago. Yeah,
it feels like a lifetime ago, and it's kind of
remarkable how quickly it failed into the background with the
market rally and the recovery. But the conversation at the
(01:05):
time was that there is this carry trade, which involves
borrowing in lower yielding currencies or lower interest rate currencies
such as the yen, and then investing in higher yielding
assets like in theory, US technology stocks.
Speaker 3 (01:22):
Or you US treasuries.
Speaker 2 (01:23):
Yeah, but the problem is that some of the discourse
around this has been. I've kind of been offended by
some of it. I've seen things out there basically implying
that the entire financial system is imploding because the carry
trade is unwinding.
Speaker 3 (01:38):
I mean, it's really crazy, Like how quickly that disappeared,
because you know, there was that megavol spike and we
were talking like historically high level is on par with
some of the financial crises, and then you know, the
expectation is like, at a minimum, this takes a while
to settle down. Yeah, and it's settled down in about
(01:59):
fifteen minutes, in a day and a half. Absolutely, what
was that? What is the carry trade? Because there is
this sort of caricature version that is out there, who
actually is engaging in it? Is it still going on?
Many questions in my head remain unanswered.
Speaker 2 (02:13):
Yeah, and one of the big ones is just how
big is it actually? And one of the funny things
that happened a few weeks ago is people were basically
looking at all the yen denominated assets in the world,
like the entire Japanese banking system, and saying, this is
the carry trade. This is how big it is.
Speaker 3 (02:29):
Okay, let's clear up some misconceptions.
Speaker 2 (02:32):
We are going to do that right now, and I
am so pleased to say that we do, in fact
have the perfect guest. We are recording here in Jackson, Haw,
Wayoming for the Kansas Fed Economic Symposium, and we have
once again run into one of our favorite all Thoughts guests,
an expert on this exact topic. We're going to be
speaking with Hyun Sung Shin. He is, of course, the
(02:54):
economic advisor and head of research for the Bank for
International Settlements and he's been looking at the carry trade
for years now.
Speaker 3 (03:01):
So Ken he actually knows what he's talking about.
Speaker 2 (03:03):
Yes, Kian, thank you so much for coming on odd lots.
Speaker 4 (03:06):
Thank you for having me again.
Speaker 2 (03:08):
It's so good to see you again. Absolutely beautiful Jackson Hall. Absolutely,
I'm so glad we could make this happen, and that
I am kind of glad that the carry trade unwind
happened just a couple.
Speaker 5 (03:19):
Of weeks ago.
Speaker 3 (03:19):
Something to talk about.
Speaker 2 (03:20):
Yeah, and you happen to be here and you're an
expert on this, So let's start with something very basic.
What is the carry trade?
Speaker 5 (03:28):
The carry trade is a financial transaction where you borrow
a currency with a low interest rate and then investor
proceeds in other higher yielding assets, and I think the
you know, the classical version of a carriage.
Speaker 4 (03:43):
Trade would be where you borrow.
Speaker 5 (03:46):
I mean, it's basically a currency transaction where you borrow
a currency with a low interest rate and invest in
a in a higher interest rate currency. But the way
that the carry trade was portrayed in the recent discussion,
I think that was you know, described in much broader terms,
where you were going into all kinds of different assets
(04:07):
and Joe, as you describe, it was a very short
lived episode of stress, but.
Speaker 4 (04:12):
At the time it was pretty intense.
Speaker 5 (04:14):
Yeah, and you know, I think, you know, we can
now look back on it with some relief that nothing broke.
You know, there was no financial market dysfunction as we
saw during the March twenty twenty episode for example. So
now we're now back to something which looks more normal.
But I think we should try and learn some lessons
from that episode.
Speaker 3 (04:34):
Absolutely, and you know, obviously there's a lot that's still
out there and much to be learned before we even
get to the future. I mean, you described what a
sort of classical carrier trait is and what we're talking about,
and I joked in the beginning, you know, it's like
borrow yen cheaply and then by bitcoin or whatever. But actually,
(04:54):
like when we talk about this, who are the actors involved?
Is it seculators who see a spread? Is it institutions
like insurance companies, etc. That have some sort of like
larger structural reason. Like who actually is engaged in such
type of activities.
Speaker 5 (05:12):
It's really the whole ecosystem, if you like, I think
the main actors would shift from from time to time.
I think one way that we could try and approach
this question is, you know, as Tracy alluded to earlier,
have large is this you know, what's the most reliable
way of trying to gauge this? Now, one way of
doing that is to look at the on balance sheet
(05:33):
lending in yend and at.
Speaker 4 (05:35):
The BIS is.
Speaker 5 (05:36):
You know, we receive data from our member central banks.
We collected and then we distributed, and we've been doing
it since nineteen seventy seven, so in a way we
are the curators of this very important banking data of
international banking business. So one thing that we can look
at in that data set would be what is the
(05:56):
cross border lending that is yen denominated, or even if
it's not cross border, what is the en denominated lending
as a foreign currency, so you know, even if the
loan is booked in a country outside Japan, it's it's
in yen, and it's it's in foreign currency. Now, one
of the things that I put in a tweet thread
is that if you look at that that number, there
(06:19):
was clearly a very sharp increase in yen borrowing as
foreign currency in twenty two to twenty three. But it's
something like forty trillion yen, So you know, that's quite large,
you know, two hundred and seventy billion dollars roughly depending
on exchange rate, But it's not the kind of numbers
(06:40):
that were being banded about in the markets, and not
all of that is going to be you know, engaged
in yen carry trade. The other way of you know,
thinking about this how is how does that borrowing take place?
And one thing that is quite interesting is that a
lot of the cross border lending is happening through the
interoffice accounts, which is to say, if there's a foreign
(07:00):
banking group which has an office in Japan, how much
is the subsidiary or the office in Japan lending out
to the headquarters in Yen. And that turns out to
be a preciseable chunk of that. Of that forty trillion,
it's around fourteen trillion would be you know that that interoffice.
But much more important than this on balance sheet is
(07:22):
the off balance sheet transactions. And here the crucial market
is the FX swap market. And FX swaps are where
you know, one party would deliver one currency. So if
I deliver dollars to the counterparty, counterparty.
Speaker 4 (07:39):
Would give me the equivalent in yen.
Speaker 5 (07:42):
With the promise that that transaction would be reversed at
a set date in the future at an agreed exchange rate.
So the exchange rate is fixed at that point. And normally,
if I'm a dollar provider, what I do is I
provide the dollars, I receive the yen in return, But
because I need to repay the yen, I need to
keep it in a safe place, so I would park
(08:04):
it in a safe in a yen asset.
Speaker 2 (08:07):
Just to be clear, Typically FX swaps it's it's not
really a trade per se, or it's not often a trade.
It's more of a hedging activity. So if I have
a lot of yen exposure, I want to offset some
of that by acquiring dollars and vice versa.
Speaker 5 (08:20):
Yeah, and that's exactly the classical the use case for
a for a swap contract. But the but the issue
here is if I receive the yen rather than parking
it in a safe place, what if I just sell
that yen on the spot market and acquire dollars, Then
I have a naked yen obligation which I will need
to meet at the time by repurchasing the yen on
(08:43):
the spot market. And that market is pretty sizeable. It's
around fourteen trillion dollars the swap market between yen and
another currency.
Speaker 4 (08:53):
That's you know, that's.
Speaker 5 (08:55):
Quite a bit larger than the two hundred and seventy
billion that I mentioned earlier.
Speaker 3 (09:00):
Just so as Tracy characterized it, there is sort of
a natural hedging need for those sort of swaps. What
types of institutions have that need to engage in the
slot market.
Speaker 5 (09:13):
It's both financial and non financial. I think typically the
textbook case is of a non financial institution. So, you know,
if I am an exporter or an importer, you know,
I would like to pay for you know, the goods
in advance, but then I need to hedge the currency
exposure in the meantime until the you know, the maturity
(09:36):
of that swap. What we've seen though, is that since
the global financial crisis, it's the financial uses of the
FX swap market which has really grown much larger. So
it's fair to say that it's the financial uses of
the FX swaps which are the line share of the
of the FX swap market. And I think it raises
(09:59):
perhaps a deeper question, which is, if you're not constrained
by the funding currency in what you can invest in
by using the swap market. In other words, suppose I
can only raise funding in one currency. Well, typically that
means that, you know, unless you have balance sheet mismatches,
you would need to invest mostly in that same currency.
(10:22):
But through the swap market, you can basically overcome you know,
that particular constraint. And what that means is it's much
better to think of financial conditions in global terms rather
than simply country by country, because you can you can always,
you know, deploy the funding in one currency and invest
(10:42):
in the assets of another currency.
Speaker 2 (11:00):
It sounds also like it's additional liquidity if you can
use FX swaps to bypass you know, specific currency constraints
in terms of funding capacity. If I was I don't
know an emerging market like exporter, and I needed dollar funds.
Obviously there's a limit to the amount of dollars that
(11:21):
I can get in a situation like that. But if
I know that I can go into the FX swap
market and get that additional liquidity, it presumably expands credit
in the overall system.
Speaker 5 (11:31):
In contractual terms, a swap is completely symmetric because you
know one party is providing one currency in return for
the other and vice versa for the other party. But
from time to time, when financial conditions vary across different currencies,
different markets, there is a if you like a lead
party in asking for that transaction, and you know there
(11:54):
is a market if you like response in supplying it.
So let me give you an example. So if I
am a let's say I'm a Euro area insurance company,
and I would like a globally diversified portfolio including dollar assets.
But most of my obligations are in euros, and so
if I were to invest, you know, nakedly in dollars,
(12:15):
there would be a currency you know, there'll be a
currency mismatch on my balance sheet. And this is where
I would go to the swap market. I would swap
the euros into dollars and that I would invest the
proceeds into dollar ponds, for example, in a way that's
like borrowing dollars. I mean, the economic rationale is very
similar to borrowing dollars in order to invest, but it's
(12:37):
not treated as borrowing in the conventional accounting sets because
you know it's a swap. There is also a countervailing,
you know, a transaction the other way, but you can
normally track what's called an EFFC swap basis to see
which direction that transaction is going. So it turns out
that typically normally it is more expensive to borrow dollars
(12:59):
in the swap market then it is to borrow dollars
in the dollar money market. And that extra premium is
if you like the additional price you have to pay
in order to access dollars. Now coming back to the
yen story, although most of the time, you know, financial
institutions are borrowing dollars in the swap market in order
(13:20):
to invest in dollar acidence, that's typically the direction of
the trade. This is why you know during financial stress periods,
you know these effects swap bases, you know spike and
then there has to be central bank swap lines to
quill et cetera. But there's nothing in principle that says
it always has to go towards a dollar, right if
(13:40):
your intention is to engage in a yen carry trade,
but through using EFFCS swaps, you know, you could borrow
yen and then you know, acquire that en obligation by
going through the swap. And so one telltale sign is
what happened to the effects swap basis during this recent episode.
And in fact, one of the interesting findings is that
(14:02):
the dollar effects basis versus the yen you know, hardly budged.
It's actually, you know, a very small movement, which is
very atypical of a financial stress event.
Speaker 2 (14:12):
Yeah, how did Why is that? Because I would have
assumed that the people providing swaps, who I assume are
dealer banks of some sort, with such volatility in the
currency rate, I would have thought that they would back
away from providing that liquidity and so the basis would
blow out.
Speaker 5 (14:31):
So there was definitely a little bit of that, but
it was by no means the same magnitude as we saw,
for example, in the March twenty twenty episode. And the
reasoning would be that in that case, the if you like.
The party that was driving that particular transaction wasn't borrowing dollars,
which needed to be you know, repaid in this scramble
(14:53):
for dollars, but rather it was the you know, repayment
of yen. Oh I see, okay, so it goes the
other way.
Speaker 3 (14:59):
So, you know, so much sort of happened during that
I don't know, there's sort of like the mini crisis
of July thirty first to August sixth of twenty twenty four,
and it came in went.
Speaker 2 (15:12):
That should be the official name.
Speaker 3 (15:13):
Yeah, that's a name of that. So you know, there
was a FED meeting that perceived perhaps to be a
little hawkers. Then we got a week unemployment report. Then
of course, you know, the end had been creeping up
right now, and you know, we'll probably still be learning more.
What is the story that you tell, like what actually
happened in those six or seven days that triggered such
(15:34):
a move and then triggered such a move that was
able to reverse so easily. What you're basic what happened
that week?
Speaker 5 (15:39):
Yeah, and clearly, Joe, there was quite a bit of
action in the currency markets. But I think what you're
referring to is the fact that equity markets were you know,
impacted very broadly across the world in a way that
you wouldn't have expected if it were a sort of
narrow carriy trait story. And indeed, I think there is
something to that in the probably we're we're putting too
(16:02):
much weight on the carriage trade as a key theme
of what happened in early August. In that yes, I
mean there may have been the classical carriage traits going
on where you borrow yen and then you invest in
the high yielding currencies. You can see which currencies fell
most in early August, and they were the Mexican peso,
(16:26):
Columbian peso, and the rand. So these, you know, these
were the destination currencies for those classical carriage trades. But
I think it's it's not really enough to explain why
there was this much more broad based stress, especially in
the in the equity markets. And I think here we
have to think about the broad issues to do with
(16:46):
how you know risk is managed, how you know risk
management itself.
Speaker 4 (16:51):
Risk management in.
Speaker 5 (16:52):
The form of loss mitigation also generates some potential for
amplification that could actually you know, make things you know
more volatile. So let me explain what I mean by that. So,
if I have a value at risk rule that says,
you know, if my risk is triggered beyond this this
var level, then I cut my position. That means I sell,
(17:15):
or if I'm lending, I cut my lines, et cetera.
From the point of view of the borrower or from
the point of view of the of the market as
a whole. You know, that is something that would actually
you know, amplify, you know, whatever stress that was there
in the first place. If I'm a lender and I
set margins, or if I'm a CECP, a central counterparty
(17:36):
or an exchange, you know, there is a margin that
I ask for, you know, the various contracts that I
deal with. Typically during stress periods, those margins go up.
So that's kind of deleveraging. Now, the way that we
deal with risk is precisely to mitigate loss, and there
is this you know, spillover effect that goes to the
broader market. And I wonder whether we should you know,
(17:58):
look back on the events of early August and if
you like, apply that lens to you know, to the
events back then. So if you know, for example, I
was not you know, borrowing in and investing in technology
stocks as you as you suggested, But it's just that
you know, you know, within my firm, you know, there
(18:20):
is a team that is doing a classical carrier trade,
but there is also a team that is you know,
leveraged the US tech stocks. But one team doesn't know
what the other team is doing. So let's say, you know,
one pod doesn't know what the other pod is doing.
Speaker 4 (18:33):
But from the.
Speaker 5 (18:33):
Firm's point of view, it looks as if you know
in aggregate that you know there is a short end
position and the long position in technology stocks, and if
that you know, risk constraint is triggered somehow, it's going
to have a much broader implication, much broader repercussion through
all of the wholdings.
Speaker 2 (18:52):
This kind of reminds me there used to be that
saying about in a crisis, you sell what you can,
not necessarily what's most impact. Did So it might be
that the most volatility is falling in the currency market
and in the carry trade, but the thing that you're
selling to reduce your risk exposure is something totally different.
Just because you can, or because it's easier to do
(19:14):
in an extremely volatile environment, and if you.
Speaker 5 (19:18):
Like, it's the it's the risk limits that are triggered.
And the way that risk limits work is if the
aggregate portfolio is suffering losses, then the risk limits are
tightened for all the different you know, different assett that
you own. And I think, you know, there is I
think something that we need to think about in terms
of how we can mitigate some.
Speaker 4 (19:37):
Of these some of these issues.
Speaker 5 (19:38):
And going back to the the FX swap discussion, the
BIS also collects data on FX swaps. You know, we
have the six monthly release of our over the counter
derivative statistics and the numbers that I've given you you know,
either all from from our data, it's all on our
web page. I think there is probably more scope for
us to have more refect fine data. For example, you know,
(20:02):
who is the instigator in having the effects well, you
know drawn up in the first place, So who is
the lead party, where is it being booked? What are
the sectors that the two parties are coming from. At
the moment, we don't have that kind of data, but
this is something that the BIS is working very hard
to try and assemble. And given the shift away from
(20:24):
the very bank centric system to something which is much
more a market based system which we have now. I
think this is really, you know, something that we need
to do as a matter of vergency.
Speaker 3 (20:49):
So can we actually, I want to go back to
your point about, you know, financial conditions being a global phenomenon,
because that has been one of the questions here in
the US, and there are people scratching their heads financial
conditions by some measures being tight, but spreads being very
narrow for credit and of course the stock market having
rocketed up. Can you flesh that out a little bit
(21:11):
more like this sort of like how we should rethink
financial conditions in a world of sort of like easy
swapping between currencies on a non bank basis.
Speaker 5 (21:20):
Sure, sure, I mean that's a very very important issue, actually, Joe.
You know, when you look at the typical financial conditions index,
let's say, you know, you take the Golden SAX index,
which is probably the best known. There are two components there.
One is really just about how high our interest rates,
how high a yields. There's another set of indicators which
measure how tight are the credit spreads? You know, what's
(21:41):
the dollar doing that kind of thing. And what's really
been quite surprising is that even though rates have been
raised to quite high levels. So the rates, those indicators
that point to how our interest rates are they've been
quite tight. But stock markets, credit spreads, you know, they've
been extremely accommodated.
Speaker 4 (22:02):
And I think one way that.
Speaker 5 (22:03):
You know, we could rationalize this is that, you know,
if we have a world where essentially money is fungible
across currencies, basically what swap does is to make money
fungible across currencies. You know, five dollars I can get
you know, yen vice versa. And in that kind of environment,
(22:24):
it's not simply how much the US money supply is,
how much you know, the Euro money supply is that matters.
Speaker 4 (22:34):
It's really about what the global picture is.
Speaker 5 (22:37):
And what are the marginal rates at which one is
swapped into the other. And I think one potential explanation
for why financial conditions have been, you know, so accommodative
in spite of the very high rates is that, you know,
money will flow to the most accompetentive section of the
money market, and the swap is the instrument that's going
to really you know, give you that fungibility. And when
(23:00):
we look at the growth of the aggregates, it's been,
you know, it's been quite rapid. So if we go
back to the GFC. Before the GFC, the global financial
system it was very much a bank based system, and
the GFC was you know, in essence of banking crisis,
and the existing BIS banking statistics covered that really well.
(23:21):
You know, in some of my work as an academic,
you know, I relied really a lot on the BIS
banking data to really you know, document what happened in
the lead up to and then the resolution. But since
the GFC, we've moved very much to a market based
system where the non bank financial intermediaries are taking on
(23:43):
a much bigger role. And in that world, the banking
statistics that the BIS puts out is only looking at
a very small part of the overall universe, and increasingly
it's the EFS, swap market and other market based intermediation
figures that we need to keep track of. And so
(24:03):
in that sense, it's quite important for us to update
our perspective on how markets work, what kinds of indicators
we need to keep track of, and basically make sure
that the official statistics are really up to scratch.
Speaker 2 (24:18):
So in the two or three weeks since the carry
trade hit the headlines, the yen dollar exchange rate has
normalized somewhat. But if you had to, if you had
to take an educated guess, how does the carry trade
re establish itself or how does it evolve from here?
Because I have to imagine there's some lingering memory, even
(24:40):
if it feels like a lifetime ago, that this actually
happened on the market. So what happens next in terms
of the carry trades evolution?
Speaker 5 (24:49):
Well, actually, I think you know, you've had guests on
on odd lots where one of their big themes was,
you know, we're waiting for this big crash because it's
going to present a huge opportunity for us to come
and really pick up some bargains. And you know, if
you were following this and you had spare powder on
August fifth, for example, that was the Monday, then there
(25:10):
were huge opportunities out there. I mean, you know, think
about the Vics. The Vics hit sixty five on the
morning of August fifth. So I think we have to
assume that many of the people who are very who
are very you know, agile, are already back in And
I think what we need to think about is, well,
first of all, we have to you know, we have
(25:32):
to be thankful that nothing broke, But at the same time,
you know, you know, we can't be complacent and say, well,
that's it, we can forget about it. I think we
have to learn some lessons from that episode, and one
of those lessons is some of the standard ways I've
been looking at markets may not be adequate. We have
to look at some of these bigger pictures ues, especially
(25:52):
those big aggregates that have been off the radar for
various reasons, and we have to bring them back on
the radar. And I think when we think about, you know,
the broader policy questions as well, especially in monetary policy,
financial conditions are absolutely key. They're a key input into
how we conduct monetary policy. And so even for that question,
(26:13):
how will financial conditions involve, we have to think about
this big a picture.
Speaker 3 (26:17):
Thinking back to that week. From a sort of fundamentals standpoint,
there was nothing that major that had happened, you know,
like I think maybe the unemployment rate cod people will
buy surprise, but data is noisy and there are surprises
all the time in both directions. Maybe the FED, I
don't know, the Bank of Japan, obviously, they're a little
(26:38):
bit out of cycle, perhaps with other central banks. I
think actually today we got a two point seven percent
inflation reading, so maybe it's all higher, but there was
nothing like that unexpected. Think about like risks going forward,
the fact that you could have such a sharp move
in such a short term. What does that say generally
about the broader I don't know, structure of the financial system.
(27:00):
And nothing broke and it did quiet down extraordinarily fast,
But what does it say about the structure of the
financial system or broadly that's something that sharp can happen
without some seemingly you know, major fundamental surprise.
Speaker 5 (27:13):
And you're absolutely right. So the fundamental economic news was
not you know, that bigger surprise. I mean, there were
some surprises at the margin, but nothing major. I think
what it does point to is the power of amplification
effects of various sorts. Yeah, and you know, as officials,
you know, as policymakers, we need to think about how
(27:34):
do we dampen those amplification effects in a way that's
going to you know, preserve financial stability and not have
one of these episodes feed into the real economy. And
you know, the typical response we would go to would
be something like regulation. If these were banks, you know,
that would be the sort of in the first port
of call. But because if these are non banks, some
(27:56):
of them, many of them are not regulated, that's not
really you know, the first port of call. But you know,
there are points of contact with a regulated financial sector
where we can do something. I think one of the
things that one of the lessons we learned during March
twenty twenty, you know, with the treasury market, you know stress,
was that we need to make sure that we don't
(28:16):
have these hugely pro cyclical margin you know variation that
means that there are four sellers onto the market. Now
you know these huge swings are justified. Well, you know,
some people were justified saying, look, I need to protect
my solvency by you know, raising the margins. But that
has huge repercussions for the others. So from a systemic perspective,
(28:39):
you know, that has negative spillover effects. So that's one
example where if we can make sure that margins are
margins don't get eroded too thinly during good time so
that you know, they're raised very sharply, that's that's really
a no brainer, and that's something that the official sector
has worked on we actually, of course, need to have
much better data on these other aggregates that you know,
(29:03):
have now emerged as being very very important, and the
BIS is on that is on that case, you know,
we are working very hard to make it much more
detail so that it's going to be much more useful.
But it's going to be a continual, you know, struggle, Joe,
because you can never declare victory because you know, the
financial system is always evolving and you're just you know,
(29:23):
you're playing catch up all the time. It's just a
case of how badly behind are you, you know, with
the realities.
Speaker 2 (29:31):
I have just one more question, which is thinking back
to August fifth, when markets were tanking, there were, or
at least there was one prominent call for one hundred
basis point emergency rate cut. And I really don't mean
to be mean spirited here, because you know, hindsight is
(29:53):
twenty twenty and we all get things wrong from time
to time. But I'm just very curious we're here at
Jackson Hall with a number of high profile policy makers.
Is there any discussion of that call or any like.
Are people talking about how ridiculous maybe that that call
actually was at the time The idea that the FED
(30:16):
was going to cut rates one hundred bases points, and
now to two or three weeks later, we have markets
near all time highs, the FX exchange rate has normalized
to some degree, and a lot of this is just
in the rear view mirror.
Speaker 5 (30:31):
I think we have to look at this with a
bit more sympathy, Tracy. I don't think we can say
definitively yes or no. You know, if we think back
to the summer of nineteen ninety eight when LTCM Long
Term Capital Management hedge fund failed, there was tremendous stress there,
and you know, there was an intermeding cut at that
(30:52):
point because what you know, we could see then was
that the real economy looked to be, you know, showing
signs of being affected. And similarly, I think with March
twenty twenty, you know that was a treasury market. Clearly
fixed income is much more closely tied with the real economy.
So I would never say never, But you know, if
(31:14):
it's so, what are we looking at in deciding whether
you would go in and to intervene, Well, you're looking
for signs of complete dysfunction in the market, where the
market is just broken down and nothing is you know,
being sold or bought, and this means that the flow
of finance to real economic activity is really suffering. I
think if you see signs of that, then I think,
(31:36):
you know, there is a stronger argument for an extraordinary intervention.
But as you say, I think, you know, looking back,
although it was a pretty you know, intense period, those
two days in retrospect, wasn't the kind of thing that
needed extraordinary intervention.
Speaker 3 (31:52):
I just have one last question, and I guess it's
sort of broad, but it's also one that I think
some of our listeners are curious about, and I'm so
I'm curious about from the BIS perspective, Like people are
always very interested in the idea of like speculative excess bubbles,
et cetera. I'm curious from the BIS perspective, do we
(32:13):
have reliable measures that can observe that. Do we have
you know, you could feel it in the error sometimes
people are talking about AI or whatever it is at
any given time, But do we have good tools to
quantify sort of the level of what we'd call speculation
in the market and at any given time.
Speaker 5 (32:32):
We always have good measures when in retrospect, so we
can always look back to the previous crisis. Yeah, so,
oh wow, we should have taken notice of that. So,
you know, if we go back to the GFC, it
was a growth rate of credit, it was growth rate
of cross border lending and in particular the growth rate
of crossborder lending and dollars, which was you know, making
(32:55):
this round trip from the US to Europe back to
the US. And what tends to happen. And I think
the BIS, like any other efficiency institution, is guilty to
some extent, is that, you know, we draw up a
checklist and say, well, next time, let's not ignore A,
B and C, and let's have a list that we
(33:16):
check and of course, you know, we have this accumulated
checklist that we take along with us we as we
experience market. But it's never going to be adequate, right,
So this time around, what happened was not really you know,
central to some of our checklists. So, you know, I think,
to be fair, I think the BIS is probably the
(33:38):
best place to draw up.
Speaker 4 (33:41):
A checklist that is closest to you know, what's going on.
Speaker 5 (33:45):
You know, we are pretty close to the ground and
in following these things, and we have very good data.
But it's something that needs constant effort. Right, It's like
it's not something that just comes easily and it's simply
a matter of you know, effortless, you know brilliant that
gives you that it's something that always needs effort. We
have to keep you know, we have to keep studying,
(34:05):
we have to keep looking, and so it's going to
be a never ending struggle.
Speaker 2 (34:10):
All right, Well we both look forward to the BIS
bubble index that you will inevitably be building. But h
thank you so much for coming back on All Loots.
Speaker 5 (34:18):
That was amazing, Yeah, fantastic, Thanks for inviting me back,
because yeah, great conversation, Joe.
Speaker 2 (34:38):
I'm so glad that we could catch up with him
and that he was basically our first episode on the
carry trade.
Speaker 3 (34:44):
I love I love talking to Hugh and it's always
just like incredibly illuminating and pleasant and great, many interesting
things there. I mean, for one, I sort of appreciated
him just explaining what the carry trade is, that different
types of actors, whether you're an import or export, or
why you would want to engage in it. Like again,
just I don't know misinformation is the right word, but
(35:06):
the amount of people who want to appine on something
like this for the first of the people who actually
have some insight is a there's quite a gap.
Speaker 2 (35:14):
Well, I do think the nuance on causality is kind
of important there, So the idea that okay, two things
kind of happened at the same time, which is the
carry trade unwound and US stock sold off, But that
doesn't necessarily mean that one thing is directly causing the other.
Speaker 3 (35:31):
Right, And it gets to like the joke every time
you know, there's some big market event and someone goes, oh,
pod blew up. But it's sort of like that, which
is basically it really if there is some volatility, if
you're losing money, it doesn't really matter what strategy you're
using or whether that strategy is central to it. You
sell something right, and so you still have that effect.
Speaker 2 (35:52):
Someone taps you on the shoulder and says, reduce leverage,
So you reduce leverage. The other thing I thought was
really interesting was the idea of the fungibility yes of money.
And I think we've talked about it on the podcast
before and I've certainly mentioned in the newsletter, but I
do feel there is a sense that okay, interest rates
went up in the US, and so credit and dollars
(36:13):
became more expensive, but that doesn't mean that they became
less available.
Speaker 3 (36:18):
Yeah. No, that's such a fascinating idea, and the idea
of like a global the need for a global financial
Conditions Index or something like that. And if you're just
looking at the US in isolation, there are things that
don't seem to make total sense in terms of especially
the disconnect between what happens with rates and what happened
(36:38):
with spreads over the last couple of years. But that
perhaps if you sort of aggregate everything together and recognize
that any there are multiple places to get funding or
get liquidity, maybe some of these puzzle pieces fit together
a bit more.
Speaker 5 (36:52):
Yeah.
Speaker 2 (36:52):
So I'm looking forward to the Global Financial Conditions Index
and the Bubble Index.
Speaker 3 (36:56):
Yes, many many indexes for the BIS to get out.
But if there's any entity that I feel confident could
do it, it'd be Hun in his team.
Speaker 2 (37:04):
All right, shall we leave it there?
Speaker 3 (37:05):
Let's leave it there.
Speaker 2 (37:06):
This has been another episode of the Odd Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway
and I'm Joe Wisenthal.
Speaker 3 (37:13):
You can follow me at The Stalwart follow Hun Song Shin.
He's at hun song Shin, follow our producers Kerman Rodriguez
at Kerman Ermann, desh Ol Bennett at Dashbot, and Kilbrooks
at Kilbrooks. Thank you to our producer Moses Ondem. For
more odd Lots content, go to Bloomberg dot com slash
od Lots, where you have transcripts, a blog, and a
newsletter and you can chat about all of these topics
twenty four to seven in our discord discord dot gg
(37:36):
slash od Lots.
Speaker 2 (37:37):
And if you enjoy odd Lots, if you like it
when we talk to Hume, then please leave us a
positive review on your favorite podcast platform. And remember, if
you are a Bloomberg subscriber, you can listen to all
of our episodes absolutely ad free. All you need to
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Apple Podcasts and follow the instructions there. Thanks for listening
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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