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I have questions about this carry trade.

For a start, how do you borrow money for the carry trade? You just go up to a bank, say lend me 100K. They say, for what? You say so I can use it to invest in overseas banks please? Why don't the banks do that themselves?

The original post described Britain having inflation therefore the currency devalues and your interest in foreign country means you have more money to pay back original loan. But in Japan they have deflation. Doesn't that mean yen becomes more valueable? Or does it mean it is the same as if inflation was zero. Because after all, things have become cheaper.

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I have questions about this carry trade.

For a start, how do you borrow money for the carry trade? You just go up to a bank, say lend me 100K. They say, for what? You say so I can use it to invest in overseas banks please? Why don't the banks do that themselves?

They do.

The original post described Britain having inflation therefore the currency devalues and your interest in foreign country means you have more money to pay back original loan. But in Japan they have deflation. Doesn't that mean yen becomes more valueable? Or does it mean it is the same as if inflation was zero. Because after all, things have become cheaper.

The Yen has become more valuable both in terms of its traded value against sterling and in terms of the amounts of goods and services it buys in Japan due to deflation.

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I have questions about this carry trade.

For a start, how do you borrow money for the carry trade? You just go up to a bank, say lend me 100K. They say, for what? You say so I can use it to invest in overseas banks please? Why don't the banks do that themselves?

The original post described Britain having inflation therefore the currency devalues and your interest in foreign country means you have more money to pay back original loan. But in Japan they have deflation. Doesn't that mean yen becomes more valueable? Or does it mean it is the same as if inflation was zero. Because after all, things have become cheaper.

Foreigners can get BTL mortgages, so I guess that is one way of getting the loan, which would in part explain why so many appear to be buying up UK property (the other part being that for many foreigners, UK property is now about 40% cheaper than it was two years ago).

EDIT TO ADD: BTL mortgages are so high right now, that I doubt that it makes it worth the hassle.

Edited by LiveAndLetBuy
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  • 2 weeks later...

http://www.marketoracle.co.uk/Article13376.html

A nice article from Market Oracle.

Yes the Gilt markets show signs of the economic recovery, but I guess that means higher rates as many here are predicting.

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I have noticed a lot of chat about 'When rates rise'.

TV, other forms of media, financial pundits brought in for the chat.

'When rates rise' is definitely on people's minds. Almost like people are being primed for it. Same thing happened with QE....

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I thought one of the YouTube vids linked was interesting too:

.

Steve Keen talks (paraphrased):

Abolish large bits of the debt as it should never have been extended in the first place, let the banks fail - a 21st century jubilee. If not, we will have never ending debt deflation, so need to kill off the parasites, nationalise the financial system and stop the financial bastards from doing the same ever again.

Very interesting... calls for a monetary revolution grow louder.

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I assume households buy treasuries through their pension and investment funds, rather than $50 a month "buy a bond" scheme.

Looks like the consumer is really cutting back..probably just to make ends meet. and 10% unemployed is gonna start to hurt .

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I've been away for a while and I've had limited internet access, hence the lack of comments.

Quick summary to bring me back up to date:

Gilts:

Gilt yields appear somewhat range-bound at present, although they've been creeping up since the additional £50bn of QE was announced. The scale of the BoE's intervention is so great that I think it's no exaggeration to say that the gilts market is now effectively a manipulated one and we can no longer look exclusively to gilt yields as an indication of investor sentiment regarding the UK's fiscal position.

As I said earlier in the thread, while the QE programme remains in place the performance of sterling is likely to act as a proxy for the normal price signals we would get from the government debt market.

10yrgilt180909.gif

Inflation:

CPI continues to come in above expectations and as we've been saying for some time, a spike is now likely at the start of the new year as the base effects of last year's high oil price works its way out of the year-on-year comparison and VAT is restored to 17.5%. It remains to be seen whether the markets will accept the BoE's argument that this is a transitory effect and the underlying risks still remain weighted towards deflation.

cpi0809.gif

Government Debt:

Public Sector Net Borrowing came in at £16.1bn in August, a pretty horrific number, but slightly less than analysts were expecting, so we didn't see any major repercussions in the markets. Cumulative borrowing for the current fiscal year now stands at £65.3bn.

psnb0809.gif

House Prices

Here's the updated inflation-adjusted fall-from-peak chart which I wasn't able to post while I was away:

HPC0809.gif

Summary

With the QE programme and government spending both in full swing we're very much in a period of limbo at present, and I don't think one can draw any conclusions regarding economic recovery or the prospects for the UK housing market from recent data.

The debt overhang in the UK remains and the Government's fiscal position is shockingly bad. I would argue that the prospect of a multi-year Japanese-style slump remains very high.

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Gilt yields appear somewhat range-bound at present, although they've been creeping up since the additional £50bn of QE was announced.

This sounds strange to my novice mind !! With the fake demand the BoE are providing with their funny money - this should be raising the 'demand' for gilts (With funny money) therefore prices/par values should rise, and yields should actually be falling as a result ?

Does this mean if the BoE had not got involved, yields would be sky high already ? With interest rates in tow ? Prices for our gilts are actually falling, even with all this fake demand... :o

Cheers

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This sounds strange to my novice mind !! With the fake demand the BoE are providing with their funny money - this should be raising the 'demand' for gilts (With funny money) therefore prices/par values should rise, and yields should actually be falling as a result ?

Does this mean if the BoE had not got involved, yields would be sky high already ? With interest rates in tow ? Prices for our gilts are actually falling, even with all this fake demand... :o

Cheers

There's little doubt that the QE purchases have been holding down gilt yields (I think the BoE puts the effect at something like 0.5%).

It's not so easy though to determine whether the upward pressure on yields is due to concern over the public finances/inflationary fears or merely a response to improving economic prospects. Investors may simply be moving from the safe haven of gilts to higher-yielding assets as they perceive systemic risk has lessened. Certainly corporate bonds have had a great run recently.

What I think would have happened in the absence of the BoE's gilt purchases is that we would have seen a repeat of March's failed gilts auction, and this would have jacked up interest rates at the longer end of the curve. This would have given the DMO a real headache, because it would have been forced to issue debt of increasingly short duration to fund public spending, painting itself into a corner.

The BoE has bought the Government some time and allowed it to sell its debt very cheaply over a longer duration than circumstances would normally permit.

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Gilts:

Gilt yields appear somewhat range-bound at present, although they've been creeping up since the additional £50bn of QE was announced. The scale of the BoE's intervention is so great that I think it's no exaggeration to say that the gilts market is now effectively a manipulated one and we can no longer look exclusively to gilt yields as an indication of investor sentiment regarding the UK's fiscal position.

Sept. 21 (Bloomberg) -- Bond yields in countries such as the U.K. and the U.S. may rise as investors shun the debt of nations with large trade deficits, the Bank of England said.

Linky

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I've been away for a while and I've had limited internet access, hence the lack of comments.

Quick summary to bring me back up to date:

[snip]

With the QE programme and government spending both in full swing we're very much in a period of limbo at present, and I don't think one can draw any conclusions regarding economic recovery or the prospects for the UK housing market from recent data.

The debt overhang in the UK remains and the Government's fiscal position is shockingly bad. I would argue that the prospect of a multi-year Japanese-style slump remains very high.

thanks for great graphics FreeTrader. Brewing nicely for the Autumn crisis that will finally seal Brown's reputation and legacy where it deserves to be in the annals of financial mismanagement and political spinelessness. Make way Eden and Chamberlain your star is soon to be eclisped.

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Thanks for that. Looks like a bit of tug of war between the market and the BoE.

Messy.

Either that or the bond market has essentially been corralled and may soon be surplus to requirement. Governments don't need to borrow money from the private sector - they have a perfectly good printing press of their own (the BoE).

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I've been away for a while and I've had limited internet access, hence the lack of comments.

Quick summary to bring me back up to date:

Gilts:

Gilt yields appear somewhat range-bound at present, although they've been creeping up since the additional £50bn of QE was announced. The scale of the BoE's intervention is so great that I think it's no exaggeration to say that the gilts market is now effectively a manipulated one and we can no longer look exclusively to gilt yields as an indication of investor sentiment regarding the UK's fiscal position.

As I said earlier in the thread, while the QE programme remains in place the performance of sterling is likely to act as a proxy for the normal price signals we would get from the government debt market.

10yrgilt180909.gif

Inflation:

CPI continues to come in above expectations and as we've been saying for some time, a spike is now likely at the start of the new year as the base effects of last year's high oil price works its way out of the year-on-year comparison and VAT is restored to 17.5%. It remains to be seen whether the markets will accept the BoE's argument that this is a transitory effect and the underlying risks still remain weighted towards deflation.

cpi0809.gif

Government Debt:

Public Sector Net Borrowing came in at £16.1bn in August, a pretty horrific number, but slightly less than analysts were expecting, so we didn't see any major repercussions in the markets. Cumulative borrowing for the current fiscal year now stands at £65.3bn.

psnb0809.gif

House Prices

Here's the updated inflation-adjusted fall-from-peak chart which I wasn't able to post while I was away:

HPC0809.gif

Summary

With the QE programme and government spending both in full swing we're very much in a period of limbo at present, and I don't think one can draw any conclusions regarding economic recovery or the prospects for the UK housing market from recent data.

The debt overhang in the UK remains and the Government's fiscal position is shockingly bad. I would argue that the prospect of a multi-year Japanese-style slump remains very high.

Love that CPI graph, is there a similar one for RPI? RPI includes the cost of mortgages, but what is this based on? Base rate, Libor, an average of SVR's or an average of mortgage products available? As you say looks like a big spike in CPI come 2010, but will RPI be the same?

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Love that CPI graph, is there a similar one for RPI? RPI includes the cost of mortgages, but what is this based on? Base rate, Libor, an average of SVR's or an average of mortgage products available? As you say looks like a big spike in CPI come 2010, but will RPI be the same?

This is the corresponding chart for RPI:

rpi0809.gif

And this is the one for RPIX:

(RPIX excludes mortgage interest payments and used to be targeted by the BoE at a rate of 2.5% before the switch to targeting CPI at 2% from December 2003).

rpix0809.gif

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http://www.bloomberg.com/apps/news?pid=new...id=ax.FBWNLB5_o

Sept. 22 (Bloomberg) -- The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.

Central bank officials are discussing plans to use so- called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. That’s where the Fed sells securities to its 18 primary dealers for a specific period, temporarily decreasing the amount of money available in the banking system.

There’s no sense that policy makers intend to withdraw funds anytime soon, said the people. The central bank’s challenge is to decrease the cash without stunting the economy’s recovery and before it sparks inflation. Fed Chairman Ben S. Bernanke said in a July Wall Street Journal opinion article that reverse repos are one tool to accomplish that goal without raising interest rates.

“One thing the Fed has to figure out is if they can launch pilot programs without spooking the market and creating the perception that they are about to tighten,†said Louis Crandall, chief economist at Wrightson ICAP LLC, a Jersey City, New Jersey-based research firm that specializes in government finance. “They are discussing things like accounting issues, and updating the governing documents to the volume of reverse repos the dealer community could absorb.â€

Fed Balance Sheet

Deborah Kilroe, a spokeswoman for the Federal Reserve Bank of New York, declined to comment about meetings with dealers. Total assets on the Fed’s balance sheet stand at $2.14 trillion, up more than a $1 trillion since the collapse of the subprime mortgage market in August 2007 triggered the worst global financial crisis since the Great Depression.

The Federal Open Market Committee, at the conclusion tomorrow of a two-day policy meeting, will probably maintain its assessment that “tight†bank credit is impeding growth, said economists including former Fed Governor Lyle Gramley.

The Fed will keep its target rate for overnight loans at a range of zero to 0.25 percent at the conclusion of the FOMC meeting, all 91 economists surveyed by Bloomberg News said.

Minutes from FOMC’s Aug. 11-12 meeting showed that among the exit strategy options discussed were reverse repurchase agreements as well as setting up a term deposit facility to reduce the supply of banks’ excess reserves.

Repo Sizes

At maturity of a reverse repo, the securities the Fed sold to the dealers are returned to the central bank, and the cash goes back to the companies. The reverse repurchase agreements contemplated by the Fed would need to be for a longer period and larger size than has been typical in previous open market operations, according to strategists.

“To be effective, the Fed would have to drain several hundred billion dollars worth of funds through these reverse repos, between about $400 and $600 billion,†said Joseph Abate, a money market strategist in New York at Barclays Plc, a primary dealer. “You may have a dislocation in the repo markets due to the supply effect of the Fed injecting such a large amount of extra collateral into the marketplace.â€

Steps taken by the Fed since March 2008 to combat the seizure in credit markets included expanding emergency lending to banks, supporting the commercial-paper market and bailing out New York-based insurer American International Group Inc.

“The timing is not now for the exit strategies to begin,†said Tony Crescenzi, a market strategist and portfolio manager at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. Talk of exit strategies “will all seem very preliminary and conditional upon evidence that the economy is moving toward a self-sustaining and self-reinforcing condition. The proof of that will be some improvement in the labor market picture,†he said.

More Participants

The jobless rate reached 9.7 percent in August, the highest in a quarter-century. Employers have eliminated almost 7 million jobs since the recession started, the biggest drop in any post- World War II economic decline.

Bernanke said in the opinion piece that reverse repos could be done with counterparties beyond the Fed’s primary dealers, which serve as counterparties in open market operations and are required to bid on Treasury auctions.

More trading partners may be needed since primary dealers have been shrinking their balance sheets the past two years, and likely can’t absorb an additional $500 billion of securities, according to Abate at Barclays.

Banks worldwide have recorded more than $1.6 trillion of losses and writedowns since the start of 2007, according to data compiled by Bloomberg.

General Collateral Rate

Securities dealers use repos to finance holdings and increase leverage. Bonds that can be borrowed at interest rates close to the Fed’s target rate for overnight loans between banks are called general collateral. Those in highest demand have lower rates and are called “special.â€

As the supply of Treasuries increases, which occurs when reverse repos take place, repurchase agreement rates are typically pushed higher. The rate on collateralized loans in the more than $5-trillion-a-day repurchase agreement market, where Treasuries are borrowed and lent, is already higher than the amount changed for unsecured borrowing of federal funds.

The overnight general collateral repurchase rate, which is typically a few basis points below the fed funds rate, opened at 0.20 percent today, compared with fed funds at 0.17 percent, according to GovPX Inc., a unit of ICAP Plc. A basis point is 0.01 percentage point. Wrightson is also part of ICAP.

When the Fed does begin, “it will use reverse repos in tandem with other draining operations,†said George Goncalves, chief fixed-income rates strategist in New York at Cantor Fitzgerald LP, a primary dealer. “The Fed won’t want to totally disrupt the repo markets and the short-term financing of Treasuries given how much debt is coming to market.â€

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Thanks PM.

It hasn't been widely noticed, but the BoE's balance sheet has shrunk over the past few weeks, dropping from £247bn on 5th August to £226bn on 16th September.

Despite some £24bn of QE injections during this period, reserve balances have fallen from £164bn to £140bn. This is because the Bank has been reducing the level of long-term repos on offer. These repo operations were supplying liquidity to the banking sector, but demand for reserves via this facility has lessened (probably because banks now have much of the liquidity they need through the QE programme).

BoE Balance Sheet 05/08/09 (PDF)

BoE Balance Sheet 16/09/09 (PDF)

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maybe just maybe the Fed/BofE printing of money has just worked then. amazing if it pans out that way. and they will even start reigning it back in... wow. i was really sceptical about all this QE to start with...

Theres no point getting more people involved than you have to when trashing the currency completely.

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This is the corresponding chart for RPI:

rpi0809.gif

And this is the one for RPIX:

(RPIX excludes mortgage interest payments and used to be targeted by the BoE at a rate of 2.5% before the switch to targeting CPI at 2% from December 2003).

rpix0809.gif

I think that people have got it wrong, and it is nothing to do with QE or money supply.

Short of a dollar collapse (which is not probable but remotely possible), positive rpi is going to be persistent longer than people think (perhaps years). Ultimately though, it will go negative for some time, along with asset values. This is coming, but not yet.

I've looked at historical parallels. This has nothing to do with the money supply. The RPI chart above fits my expectations precisely.

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