Hedge ledge

OK, we all know the G7 is meeting this week. Most of us expect relatively little, which means that the yen gets creamed next week by greedy carry traders, right?

Not so fast, my friend.

There's also the little matter of Big Ben testifying before Congress and Japanese Q4 GDP. Either of these could temporarily upset the yen weakness apple cart, and indeed the risky asset apple cart more generally.

Macro Man has his equity market hedge on; now it's time for the currency market hedge. The time to buy yen calls is when the yen is weakening, not strengthening. It's hard to believe after all the Euro finance minister yakking, but EUR/JPY is all the way back to 158. It's time to hedge.

Macro Man buys EUR 25 million 155 yen calls and sells EUR 25 million 159.90 yen puts, both expiring February 21, for zero cost.

Hopefully he gets assigned on the 159.90's- he can always buy EUR/JPY back, and it would almost certainly mean that the rest of the portfolio is kickin' ass and takin' names. And if nothing much happens, well, nothing's been spent so nothing is lost.
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February 9, 2007 at 3:03 PM ×

I got this from Everbank's Chuck Butler this morning:

"Then came the news that the Russian Central Bank announced changes to their FX Basket moving the euro component to 45 cents, and dollars to 55 cents... This move caught the markets off-guard a bit, in that Russia had been saber rattling for some time now regarding a change, but when, was the question.

The move falls in line with all the other Central Banks that have been changing their currency mix for the last year... Recall, it all began with an announcement by South Korea a year ago, and that has led to a flood of a changes in currency mixes by Central Banks... Another reason, that euros have become a strong challenger to the dollar for the world's reserve currency!"

Good thing you hedged! OldVet

February 9, 2007 at 4:48 PM ×

quick question Macro Man -

Given the lack of volatility in fx markets, notably the 600 pip range held by EUR/USD in May-Nov 2006 the carry trade was in full swing. There is also a contraction of the average true range in the majors in recent years. Taking into consideration the likelihood of this to hold steady or continue would this not put a bias in favour of the carry going forward amongst the other factors you previously mentioned in your post with the good Doctor?

Also I find it ironic that the prior G7s communiqué mention excessive volatility in exchange rates as being unwelcome by them , this very factor then appears to promote the carry that leads EU officials to verbalise their brewing discontent with EUR/JPY with Roth and Co. moaning about EUR/CHF

Enjoy your blog, always a pleasure to read and hope you have a nice holiday - I presume the Alps are calling :-)

Macro Man
February 9, 2007 at 5:11 PM ×

Yes, I think it is fair to say that low volatility contributes to the attraction of carry-based strategies. A very curious phenomenon is that the carry-to-vol ratios of many EM currencies/ bonds have come quite a bit lower over the past decade (good luck finding a 40% interest rate these days!), while the equivalent ratios in dveloped markets has more or less never looked better.

This is surely a factor in the attraction of G10 carry trades for a number of investors, though I stress: a very significant proportion of the investment community that trades currencies does not pursue this strategy. Else the surveys of 'real money' positioning would be similar to carry baskets, and we wouldn't hear teeth-gnashing from macro discretionary guys.

Thank you for your kind words, and yes, I am being taken to the cleaners, er, the mountains, by rip-off Britain, er, travel companies. An annual pilgrimmage at the altar of Ullr!