When I talk about "carry trades" and their risks I usually get a spike of attention from the students of the Master in Finance in which I give a series of lectures. The reason? They have a flashy, often dramatic dynamic that doesn't go unnoticed.
For example, a "carry trade” of the past decade, a lot popular with hedge funds (hedge funds), was this: I invest in short-term bonds named in Australian dollars (AUD), a currency with relatively high interest rates, getting me the money borrowing on the Danish market, due to the low interest rate applied to loans in crowns (DKK). In practice, in this way we took home the difference between the interest rate in AUD (higher) and that in DKK (lower).
From 2001 to 2007, the investment strategy in question went like a rocket, see chart 1 (click image to enlarge).
The trend is not bad, considering that, for the economic theory classic, these operations shouldn't even exist or at least they should have an ephemeral life like that of a butterfly. This is because in a "perfect" market they would soon be wiped out arbitrage operations that quickly would have eliminated its convenience. And instead… like other “market anomalies” they often last for months or years.
But let's see how the story of the AUD-DKK "carry trade" ended, widening the time window and finding out what happened in the following months, look at graph 2 (click on the image to enlarge and scroll). The epilogue was typical of the "carry trade": a crash in no time, at a speed that is often higher than the speed at which investors exit the transaction.
Consider that in 1998, the famous Hedge Fund Long Term Capital Management (“Long Term”… observe with what irony history has brutally grinded this name) collapsed due to a series of “carry trades”, gone very badly, which largely had as their object thepurchase of high-yield government bonds (construction sector Italians and passes Spanish in primis) funded a low interest rates on the Japanese market. Incidentally, the financial crisis and global risk resulting from the bankruptcy of Long Term Capital Management prompted the then Governor of the Fed, Alan Greenspan, to flood the market with liquidity, starting that era of “money doping” that continues to this day.
Are Italian and European banks operating carry trades?
Now that you (hopefully) have an idea of what carry trades are and what risks they involve, let's talk about the Italian and European banks.
In the Italian case, according to the Statistical Supplement to the Bulletin of the Bank of Italy, section "Money and banks", from 2010 to today the percentage of Italian government bonds present in bank balance sheets has increased by 96% ninety-six!), that of securities from other countries increased by only 41%. According to data from the European Banking Authority aEuropean banks also increased the share of Italian government bonds on average from 2010 to 2012 of 27% in their wallets. No wonder: first of all, these are investments with a good yield and then, mind you, the purchase of government bonds by the banks saved the European financial system from implosion.
With what money did the banks buy these bonds? With i money loaned cheaply by the ECB.
Here we go, let's recap:
. banks are financed at very low rates by the ECB
. then they invest in government bonds with a high yield.
Doesn't this situation remind you of something? O yes, we are faced with a vast "carry trade" involving Italy and the entire European banking system. With all the associated risks. In fact, we have passed from "carry trades" performed by individual operators, albeit important ones, to those carried out at a system level (it is really true that the markets follow a fractal geometry where things at a micro level have the same structure as the larger ones...) . We are facing the mother of all "carry trades".
Now even if the probability that a large systemically important European bank could fail is very low indeed, this is neither a normal nor a desirable situation, because it is potentially unstable.
This largely explains why (on average) the shares of Italian (and European) banks are more volatile than those of other sectorsi: in fact, they react very badly when the markets are negative and operators are very risk averse, but offer excellent performances when the financial climate improves.
If you are interested in investing in bank shares know that it is important to wisely dose these instruments in your portfolio based on your propensity for risk (you don't know how much risk you are willing to bear? Answer the financial DNA test offered free of charge on the Advise Only website), because they can offer great opportunities, but they also include non-trivial systemic risks.
