Happy Friday!

📝 Focus

• Cruise (outta) Control

📊 In the Markets

• End Game for the ¥ Carry Trade?

📖 MoneyFitt Explains

🎓️ The Carry Trade ($¥)

📝 Focus

Cruise (outta) Control

Royal Caribbean Cruises, the second largest cruise giant after Carnival by passenger and revenue market share (23% vs 43%) but the largest by market value (share price X number of shares, at $28bn vs $23bn), posted record quarterly revenues, beat forecasts by 17% and raised its full-year profit forecast by a third.

..... ▷ That was enough to send its shares up 9% to a three-year high and a 125% gain for this year alone. The cruise industry continues to benefit from pent-up demand as travellers pick cruises as a good value alternative to land-based vacations, allowing RCL to raise prices and boost margins. Occupancy was 105%, up from 82% a year earlier.

..... ▷ All looking shipshape for RCL, but the upbeat forecasts do contrast with market leader Carnival, which last month cited marketing and labour costs underlying their lower-than-expected figures. Nonetheless, along with #3 player Norwegian, shares in all the giant cruise lines have done well in 2023. The nature of cruise lines is to have huge fixed costs (ship maintenance and staff) and hence very high “operating leverage”, which means that the revenues from each incremental passenger flow pretty much straight to the bottom line.

..... ▷ A fleet of immense ships means cruise liner companies usually use debt financing, but with pandemic shutdowns, total debt for RCL more than doubled, adding to the fixed costs for the company. Financial leverage is not the same as operational leverage, but the short-term bottom-line boosting effect is similar. But it does leave companies in the sector much more vulnerable to future slowdowns.

Royal Caribbean was founded in 1968 by a group of Norwegian shipping companies and was named to appeal to the North American market. Its name was just made up to evoke a sense of luxury, elegance, and grandeur, promising a premium experience… but it has no direct connection to any actual monarchy. The name "Royal Caribbean" is just an aspirational brand image.

📊 In the Markets

US stocks opened and held higher on economic growth data for the second quarter that was much stronger than expected and faster than in the first quarter, plus the comments from Fed chief Jay Powell after Wednesday’s expected interest rate hike suggesting that a “soft landing” (see below) was still possible.

..... ▷ But then, around lunchtime, news emerged that the Bank of Japan (BoJ) was considering allowing long-term interest rates to rise above the previous 0.5% cap. Nikkei Asia reported - at 2 am Japan time - that on Friday, the BoJ would (finally) discuss changing its market-distorting “yield curve control” policy of buying targeted bonds to keep yields down. Japanese Government Bond (JGB) prices then fell, sending yields up (the yield is the actual interest rate at a particular bond price, so bond yields and prices move in opposite directions.) This, in turn, sent US Treasury (i.e. US government bond) yields higher and reversed the stock market’s morning gains, pushing the main indexes into loss-making territory.

End Game for the ¥ Carry Trade?

Higher JGB yields also led to a stronger Yen against the USD to JPY139 from JPY141 earlier in the same day (meaning it takes fewer Yen to buy US$1). Higher interest rates ahead in Japan vs what looks to be The End Game of both the US and Euro interest rate hiking cycles suggests more Yen appreciation could be ahead, as the difference in interest rates narrow (not a forecast!)

..... ▷ A “carry trade”🎓 is when investors borrow money in a currency with a lower interest rate (like JPY or CHF) and invest it in a currency with a higher interest rate (like USD or EUR.) The goal is to profit from a return roughly equivalent to the difference between the two rates, which is known as the “carry.”

..... ▷ After this week’s hikes, the Federal Reserve has hiked interest rates by 5.25% points from about zero per cent since March 2022, while the European Central Bank has gone from minus 0.5% in July 2022 to 3.75%. Meanwhile, the Bank of Japan’s base rate remains at minus 0.1% while 10-year JGB yields are pinned at zero per cent, with a +/-0.50% trading band allowed on either side. It is this band which may be less strictly managed by the BoJ from Friday.

..... ▷ Carry trades can be high-risk trading strategies since they are often highly leveraged and can be very crowded (meaning everyone and their Uber driver is in it already.) This falls apart if the borrowed currency shoots up… or looks like it might potentially do so. And if it does, with a narrowing of the carry, the immense outflow of investments from Japan into the rest of the world could swiftly reverse (see “New BOJ Boss’ Job: Don’t blow up the world” from April.)

Soft Landing - a mini-explainer

- This is where after a period of strong growth or high inflation, an economy slows down but doesn’t crash into a recession, leading to severe unemployment.

- It is normal in an economic cycle for economies to speed up and slow down, with inflation and employment levels usually the main focal points for governments and central banks.