What is Yen Carry Trade?
In the Bank for International Settlements (BIS) Quarterly Review dated March 1999 there is a section titled "The yen carry trade and recent foreign exchange market volatility." This report describes the phenomenon known as the "carry trade" and then explains what happened in the foreign exchange markets with regards to the Japanese yen during the period from 1995 to 1998.
Japan's low interest rates, an anomaly in the financial world, result from Japanese central bank monetary policy, which has, Richard Jerram, the Macquarie economist, said, "defied orthodox economic thinking for more than 20 years."
For the carry trade, the ploy involves borrowing yen and immediately selling them for a currency that is either itself a higher-yield instrument (e.g., the New Zealand Dollar, Brazilian Real and Mexican Peso) because of the interest rates in the other country, or using them to buy higher-yield or higher-risk instruments (e.g., Turkish stocks). Because it combines risks of high leverage with risks inherent in a higher-yield asset class, the carry trade is highly sensitive to foreign exchange moves and liquidity fears.
As reported by The Times of London, hedge funds have long used the carry trade for cheap leverage, but there are also thought to be vast exposures to yen volatility in the Thai, Korean, and Indonesian banking sectors, where the Japanese currency has been borrowed heavily to meet funding needs. The British banking sector turned to a version of the carry trade -- yen-denominated bond issuance -- when credit conditions tightened around the Northern Rock crisis. Indian banks' use of the carry trade surged 180 per cent between 2005 and 2007.
After seven years of providing the cheapest source of funds for investors buying higher-yielding financial assets, the yen is appreciating as $US587 billion ($757 billion) of subprime mortgage-related losses force banks to restrict credit. It strengthened 4.4 percnt; on a trade weighted basis in September, according to the Bank of Japan's effective exchange rate, the most since August 2007, when the seizure in capital markets began.
The yen rose toward a six-month high against the dollar after the International Monetary Fund said the world economy is headed for a recession next year, with expansion in the U.S. forecast to grind to a halt. The yen also traded near its strongest in three years versus the euro on speculation a global stocks sell-off will prompt investors to reduce holdings of higher-yielding assets.
The current stocks dismal performance helped deter carry trades.
Richard Benson, who oversees $US14 billion of currency funds at Millennium Asset Management in London refer the Yen as “ a counter-cyclical currency, When the global economy looks bad, the yen should do well”.
The US Dollar/Japanese Yen currency pair continues to trades almost lock-step with the Dow Jones Industrial Average (highly correlated), while the US dollar has likewise moved with the price of Crude Oil through recent trade.
The correlation of US Dollar/Japanese Yen pair and the Dow Jones Industrial Average is currently almost at its highest. The current investment theme is every downward move in global equity indices will be follow by short positions in the low-yielding Yen.
Dow Jones Industrial Index
USD/YEN
Yesterday, stocks plunged, sending the Dow Jones industrial average down 679 points -- more than 7 percent -- to its lowest level in five years. Refer to Dow Chart above. The USD/YEN was moved up to previous day high during the Asian session, moved sideway during European session with high volatility before plunge down during US session.
October is usually the best time for bottom buying for the stocks. Yesterday heavy fall in Dow indicate further downward fall is expected before market stabilize. The USD/YEN chart indicates that the pair is currently looking for the 4th wave of Elliot Wave retracement before the final 5th wave down. Retracement is expected at 38.2% level.
