Whatever happened to the Carry Trade?

Tucked away at the end of the quarterly review from the Bank for International Settlements or BIS was a reminder of an issue that has been a theme on here for some time but hits the headlines rarely now. Well until the next crisis! This is the Carry Trade which is where borrowers who may be institutional, corporate or most dangerous of all an ordinary person borrow in another currency to which they use every day and more particularly earn in. This poses two clear and present dangers of which the first is the risk to those who do this as they are exposed to currency moves. Ironically if done on a large-scale as happened back in the day with the Swiss Franc and the Japanese Yen it lowers the currency and so not only is the interest cheaper but you have a capital gain. What could go wrong? Well we will come to that. But this same effect turned out to make things uncomfortable for both Japan and Switzerland as their currencies were pushed lower and lower.

What’s going on?

If we ask Marvin Gaye’s famous question we find that the BIS can give us some answers. Here is something which was already known but it does no harm to be reminded of the scale of it.

McCauley et al (2015) have demonstrated that since the Great Financial Crisis, the outstanding US dollar credit to non-bank borrowers outside the United States has increased from $6 trillion to $9 trillion.

Actually initially the US Federal Reserve would probably have welcomed the downwards push on the US Dollar but as we note a stronger period for the US Dollar something of a squeeze will have been put on the borrowers. A real squeeze was put on places like Russia and Ukraine when their currencies fell due to lower oil prices and the invasion of Crimea as they had US Dollar borrowings. The BIS regards this as causing bank deleveraging.

The Euro and QE

According to the new data there was a change when the ECB began its QE program back in January 2015. Not only is there more activity it is concentrated in particular locations.

For advanced European countries outside the euro area, the euro share in cross-border bank lending (32%) is almost equal to that of the US dollar (35%). In emerging Europe, the share of euro-denominated claims (40%) exceeds that of US dollar claims (31%). By contrast, non-European EMEs borrow only a small fraction in euros (6.5%).

As to the exact numbers the BIS records a rise as QE began but then the numbers get confused as there is always so much going on in the fog of finance but we do get a conclusion.

More concretely, higher shares of euro-denominated claims were associated with greater expansions in cross-border bank lending. This result appears to be driven primarily by lending to advanced economies outside the euro area.

Looking at the individual data I note that there seems to be borrowing in Euros going on in what is called emerging Europe again. Greek banks seem to be especially involved in Poland and Hungary which is troubling considering what happened last time around. Spanish banks seem to be active in this area full stop. For a small country Luxembourg seems to be involved a lot. So worrying signs which are just hints at this stage.

As to the players last time around it is harder to say as for example there is activity in what is classified as “others” but Austria is grouped in there with quite a few other countries. The Italian banks seem to be doing less than last time but of course many of them have what might euphemistically be called different circumstances these days.

There are echoes of the past here and whilst the BIS uses neutral language it poses more than a few questions.

The results are particularly relevant for policymakers in borrowing countries that rely heavily on cross-border bank lending.

Also there is this.

For example, euro lending by Swiss banks to Poland can be affected by the ECB’s monetary policy, even though neither country is part of the euro area.

This warning is more general and may even be aimed at the US Federal Reserve for this week.

our findings suggest that policymakers should closely monitor the currency denomination of cross-border bank lending as they assess the potential impact of possible policy moves, both in their own economies and abroad.

It sounds a bit like “Be afraid, be very afraid” ( the film The Fly I think) does it not?


On Saturday I pointed out on BBC Radio 4 a consequence of negative interest-rates in Sweden which is not predicted in conventional economics which is increased saving. Well here is Bloomberg from earlier this month on another one.

The G-10 currency is cheap, thanks to the Riksbank’s negative interest rates. Traders have been borrowing in low-yielding kronor and using the funds to invest in higher yielding currencies, such as Australian and New Zealand dollars, according to Royal Bank of Canada.

The Riksbank will welcome this in the same way I described for the US Federal Reserve as it wants a lower currency to help push inflation higher. Of course the ordinary Swedish worker and consumer will not welcome this at all and there is a deeper danger as should this end the experience of Switzerland and Japan shows that it blows up with a painful currency surge.

What could go wrong with this sort of thing?

In the past three months, selling the krona to buy the kiwi and Aussie dollars, as well as higher-yielding currencies such as South Africa’s rand and Brazil’s real, has returned 9-16 percent, beating the 6-12 percent paid by euro-funded deals and the 4-10 percent generated when using the U.S. dollar.

What about mortgages in Eastern Europe?

I decided to take a look at what was something of a disaster last time round as cheap interest-rates on Swiss Franc and Euro denominated mortgages turned into large foreign-exchange driven capital losses. From the National Bank of Poland.

Banks hold a large, long on-balance-sheet FX position related to the portfolio of foreign currency loans.

The information in the latest Financial Stability Report is as shown below as we get flashes of what was the position at the end of 2015.

The direct costs of restructuring, i.e. conversion of the principal of all loans at the KWO rate, can be estimated at about 35 billion zlotys. If, however, restructuring is used only by borrowers from the years 2007-2008, the costs would be approx. 29 billion zlotys.

There were also indirect costs.

The current value of such reduction in revenue, assuming that all borrowers would take advantage of compulsory restructuring, may be estimated at approx. 21 billion zlotys.

An idea of the amount of individual distress is shown below.

The total value of foreign currency loans with LtV greater than 100% can be estimated at around 77 billion zlotys.

Hungary another country where this issue was particularly prevalent there was a socialisation of the issue a while back. From the Financial Times.

Hungary’s government agreed with banks to convert up to €9bn of foreign currency loans into forints at the then market rate.

Those who took out foreign currency mortgages in Cyprus also faced falls in the value of the asset. From the Central Bank of Cyprus.

Given that until 2015Q1 house prices in real terms had dropped by 34,5% from their peak, in order to complete the correction of the bubble they should theoretically be reduced by a further 9,7% in real terms (4,7% in nominal terms). This would bring house prices at levels corresponding to 2006Q2.

Cyprus Property News told us this on the 7th of this month.

Although Swiss Franc loans declined €274 million in the first half of the year, 80 per cent of the remaining €1,778 million are non-performing according to the head of the Cyprus Central Bank’s Supervision Division.

Time for Ms Britney Spears.

Don’t you know that you’re toxic?
Don’t you know that you’re toxic?


There is much to consider here and we have an issue which is only likely to be made worse by the way that so many countries now have negative interest-rates. Great care is needed with any numbers in this arena as they invariably turn out to be inaccurate but what we do know is that there is great risk here. Also we know that this is a risk exacerbated by all the monetary stimulus that is going on.

Speculating in currencies is a dangerous game for those with lots of capital backing. I fear that in the future we may discover that one more time the unwary have been seduced into it.

BBC Radio 4

I was on Money Box on Radio 4 over the weekend. It was live on Saturday lunchtime and then repeated last night. Here is the clip.



12 thoughts on “Whatever happened to the Carry Trade?

  1. Radio 4
    Excellent! Having the other guy trying to defend the indefensible must have made things very easy for you. I just hope you are not marked as someone who will hold people to account and is therefore too dangerous to be talking on national radio.

    I wrote in and asked for you to appear more often.

    • Hi Chrisrick

      Thank you on both counts. I hope not and as the whole idea of a critique of the Bank of England was mine it appears that Money Box are willing to have non establishment views on the BBC. They knew what was coming from me in general and to some extent specifically as they grilled me beforehand. I gave them a view of the world which works much better than the establishment one.

  2. Very interesting, as usual. While institutions can make judgments about all this, I just feel pretty sorry for the individuals who have ended up owing far more than they ever expected. I know that they should have known better etc, but I just don’t think that these products should ever have been marketed as a sensible way to have a mortgage.
    Matching liabilities to assets or income always seems like a sensible choice, but then people often make senseless choices…I recall a programme years ago about the sufferings of pensioners who had retired on UK Sterling pensions and who had moved to Eurozone Spain. A number of them thought that the UK government should make up the difference when the pound fell against the Euro (I don’t remember anyone asking to give money back when the pound strengthens against the Euro, but my memory may be fading).

    • Hi James

      You are right I think to express sympathy for individuals affected by the foreign currency mortgages. The stories that bank salespeople persuaded/seduced them into it are convincing and it was in many cases another type of miss selling.

      As to currency moves we all face them either indirectly ( prices changing here) or directly when we either go abroad or do business abroad.

  3. Shaun, glad you raised the issue of people saving more when interest rates decline as this is what is happening in the real world and not in the world of economic theory. I have lost count of the number of older people who have told me that they have cut discretionary spending and are saving hard due to the fall in interest income and future insecurity. Unfortunately the discussion on R4 was all too brief.

    • I’ve made this point too, on a number of occasions, and I’m neither an economist nor a psychologist.
      Who are these idiot professors?

  4. I doubt anyone would take on a cross currency mortgage if they were told there is effectively no ceiling on the downside risk. If a currency totally collapsed due to hyper inflation then the amount of money to pay back in another currency tends towards the infinite. Unless you have income in the currency you are paying the debt off in then you are completely at the mercy of currency fluctuations.

  5. Shaun,
    I listened to your short excerpt on R4 and I think it went well. The other economist didn’t get a blog plug like you did. I reckon theres a pent up demend to hear the other side view since its obvious now that Govt doesn’t have a clue where it is going.

    A small tip is that for your listening audience, they need it spelling out a little simpler, here on the blog we get to read and follow, words and the thought. On the radio it probably needs “the fall in the currency is in some ways a benefit to the UK, I have calculated that a 7% fall against the dollar is the equivalent of a 2% fall in interest rates…. etc”.

    In general though you came across forcefully and with conviction, which if course so few establishment folk can, since they read from a script, like your sparring partner. I hope you get more airtime!

    Regarding the carry trade,I am intrigued what would happen for the reverse scenario. People borrowed in Swissy as I understand it because they found the rates lower (without factoring currency risk). What if people who get negative interest in the bank start taking their deposits to say China Banks which pays 5% how does that affect international money flows? More realistically, if the USA takes rates to 2%,wouldn’t cash flow there and leave the EU system. Is this the real reason all Western Govts have to chase their rates down in unison and why Janet Yellen really can ony talk about rate rises since doing them would cause a deluge flood of demand for the dollar.

    I notice out of coincidence with my idea the FT and MSM were disrespecting the Yuan and credit leverage in China, perhaps a pre-emptive strike to stop any money going that way…

    Cheers Paul

  6. Hi Shaun,
    Well Done on Money Box; though I’m a little disheartened, but not surprised, that some of your points just seem to get ignored. I can almost feel an inaudible groan when your comments begin to question the wisdom of TPTB.
    Keep at it.

    Life is getting expensive for UK expats down in kiwiland.

  7. For Southern European loans, the criteria appears to be having friends and/or paying bribes to the loan approval staff. IMHO this includes unicredit ….

    Crony loans, what could go wrong ?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.