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High-yielding NZ$ bears brunt of sell-off as investors cash out in flight from risk

Key currencies fall as investors sell assets funded by yen loans

THE United States sub-prime crisis that has wreaked havoc on stock markets has spread to currencies, hitting key units like the sterling and leaving experts wondering where it will end.

In three weeks, the sterling, the euro as well as the New Zealand, Australian and US dollars have plunged against the yen, posting drops of between 6 per cent and 14 per cent. The high-yielding NZ dollar took the biggest hit.

The US dollar fell below the key psychological level of 117 yen yesterday while the euro slid past 160 yen and the NZ dollar went under 85 yen.

‘It is madness,’ said Fortis Bank strategist Joseph Tan, on the turbulence in the foreign exchange market yesterday afternoon.

A flight from risk has caused investors to step up their exodus from investments in Europe, the United States, Australia and New Zealand, which were funded by ultra-cheap yen loans – a popular practice known as the ‘yen carry trade’.

The exit from assets denominated in these higher-interest currencies and ploughed back into yen – known as an unwinding – caused the currencies to dive against the Japanese unit, said analysts.

‘The kiwi, sterling and euro have broken through their support levels. What you are seeing is a massive unwinding of the carry trade,’ added Mr Tan.

A trigger for yesterday’s rush to unwind carry trades, said analysts, was news that yet more billion-dollar funds have stopped investors’ redemptions. This has led investors of other funds to fear that if they do not cash out, they will be caught out as well.

And yesterday was the last day for investors of certain hedge funds – those requiring 45 days’ notice for redemptions – to ask for their money back if they want to cash out at the end of this quarter, reported the Financial Times.

‘Fear has spread from funds invested in sub-prime assets to the credit markets, to just about anything,’ said United Overseas Bank economist Jimmy Koh.

If the unwinding picks up momentum, it would be a double whammy for asset markets, said economists.

Over the past week, central banks have been pumping liquidity into markets as risk aversion arising from the sub-prime debacle caused banks to be reluctant to lend.

Economists fear that if the carry trade unwinding snowballs and pushes up the Japanese currency further, yen denominated loans will become expensive and more investors will cash out. This, in turn, will lead to a deepening crunch in liquidity.

‘The unwinding is substantial but it’s not the worst yet,’ said Mr Nizam Idris, UBS director of foreign exchange research and strategy. ‘In the last three weeks, it was institutional investors unwinding their trades. Now we’re seeing the second leg of unwinding, by Japanese retail investors, your ‘mums and pops’.’ Mr Tan said that while carry trades are still largely profitable, fear is now ruling behaviour: ‘At this point in time, nobody in his right mind would get in.’

As for how much further the high-yielding currencies could fall, ‘it’s a multi-billion-dollar question’, said a Singapore-based currency strategist with a US bank.

‘Seriously, I have no idea how far this thing would go. Our forecasts don’t work anymore, because all the technicals have been broken on the downside,’ he said.

‘Suffice to say, the past three weeks is probably the tip of the iceberg.’


Source: The Straits Times 16 Aug 07


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