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good morning. Yesterday, UPS reported its second consecutive quarter of strong package volume growth after a long post-pandemic slump. It remains to be seen whether this is a victory for the U.S. commodity economy, for Mr. Shein and Mr. Thame, or for all three. Please let us know your order details: robert.armstrong@ft.com and Aiden.reiter@ft.com.
Is yen carry funding the rise in US stocks?
BCA Research’s Dhaval Joshi believes the yen carry trade is an important — in fact, important — factor in the rally in U.S. tech stocks, so the biggest risk to the bull market is a stronger yen.
His argument is based on the historically large difference in real interest rates between the United States and Japan. Below is his graph showing the difference between the two countries’ real policy rates.
U.S. tech stock valuations recovered from their collapse in the first half of 2022, just as the gap closed in mid-2022 and yen lending for U.S. assets became correspondingly cheaper, when the Fed began raising interest rates. Ta. interest rate. Joshi provides this neat graph showing how tech company valuations have decoupled from 30-year Treasury yields and started tracking the weaker yen (the brown circle plot is inverted, pointing upwards). means that the yen is weak against the dollar).
From all this, Joshi concludes:
Yen borrowing at significantly negative real interest rates has accelerated recent inflation in the valuations of US high-tech companies. . . The biggest risk to the bull market is not a U.S. recession. The biggest risk is the end of sharply negative real interest rates in Japan and the United States.
Interestingly, this outcome can be brought about by trouble on either side of the deal.
Causation can go in either direction. As happened in July and August of this year, a rise in Japan’s real interest rates relative to the US and the resulting appreciation of the yen will devalue US tech stocks. Alternatively, if the hype and expectations around generative AI are dashed, the leveraged exposure of yen funds to US technology could be unwound, resulting in a stronger yen.
Joshi suggests investors hedge this risk by going long the yen.
This theory is attractive to Unhedged for several reasons. That’s contrarian. And it’s great to have a story as to why U.S. stock valuations have risen and remained high despite rising bond yields (a puzzle we discussed yesterday). And there’s no particularly good alternative story, other than some “animal spirits” waving their hands or someone tweeting about the resilience of the U.S. economy.
But correlation can be deceptive. And in a world where Japan’s official policy has been hawkish (and haphazard) and US policy has recently shifted in a dovish direction, many investors out there are willing to make trades like Joshi’s. We wonder if we would have the courage to do so. Especially after this summer’s carry trade scare and given the volatility in the interest rate environment ahead of the US election.
We attempted to reproduce Joshi’s policy rate differential graph using data collected elsewhere. This is what we got:
In our version, the interest rate ceiling is already 1.3 percentage points closer, and the trend is clear.
James Malcolm, FX strategist specializing in Japan at UBS, says:
The carry trade itself has completely disappeared (this summer). There was a dramatic move. What always follows these events is a tightening of risk limits. . . I spend a lot of time every day talking to people who trade with Japan. Overall, FX players have had a rough time in recent months, with little profit cushion. At the moment they don’t have the ability to take risks.
Forex consultant Mark Farrington agrees: “Given how high the volatility is, it’s less likely that traders are still using yen carry.” “There are too many extraneous risks.”
If you have any intrepid carry traders, please email us.
(Armstrong and Leiter)
housing
A few months ago, we said that the US housing market was absolutely terrible. Inventories were increasing, but prices were rising unaffordably. Since then, the situation has gotten even worse. Inventory of new homes is currently at its highest level in more than a decade. John Burns Consulting charts:
Meanwhile, more used homes are coming onto the market after years of reluctance by homeowners to part with cheap mortgages. “The[mortgage]lock-in effect is slowly fading,” says Rick Palacios of John Barnes Consulting. as) property and hazard insurance.
In a market with high inventory, you might expect prices to fall. Not so in the failed U.S. housing market. Supply is increasing “at a time when there is no demand,” said Troy Rudtka of SMBC Nikko Securities America. Prices of newly built homes are falling, but sales are sluggish. Prices of existing homes are still on the rise.
Home builders are pulling out. Housing permits and housing starts remain sluggish.
New supply is slowing because builders are building less and mortgage rates are stagnant.
An economic slowdown would lower interest rates and encourage markets to open up, but rising housing inventories and reduced appetite among home builders make an economic slowdown even more likely. Housing investment is an important “variable factor” of GDP growth. The Bureau of Economic Analysis highlighted the slump in housing investment in the second quarter, when there were more buildings than now. But no one will be happy that the housing market will ease due to the recession.
(writer)
A book I read often
PMSR.
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