Currencies | Sep 21 2009
By Chris Shaw
As noted by Commonwealth Bank currency strategist Joseph Capurso, there is increasing speculation in the market the US dollar already has or will replace the Japanese yen as the world’s major funding currency for the “carry trade”, for which the yen has been the primary option for almost 20 years given Japan’s low interest rate structure.
The carry trade is where low yielding currencies are sold or investors borrow money in a low interest rate currency to invest money into currencies where higher yields are achievable, with a typical example in recent years being to sell the yen to buy assets in Australian dollars given the higher interest rates on offer in the Australian market.
This speculation of the greenback replacing the yen in this regard is misplaced in Capurso’s view as for the US dollar to permanently push aside the yen as the primary funding currency, US dollar interest rates need to be permanently lower than those in Japan. While US rates now are close to zero he doesn’t see this as a permanent trend.
More likely in his view is US interest rates will eventuall increase, an outcome he notes is supported by one year LIBOR and bond markets at present, while Japanese interest rates are likely to remain very low. This means the yen is likely to remain the preferred option as a funding currency.
As an example of why Capurso points to the Australian Dollar (AUD)/Yen and AUD/USD (US Dollar) pairs, noting the current outlook suggests the Australian interest rate advantage against the yen will increase by more than will be the case for the US as on the bank’s estimates the Reserve Bank of Australia (RBA) will lift the cash rate by 200 basis points by early in 2011 against 125 basis points of increases in the US. At the same time interest rates in Japan are likely to remain unchanged at 0.1%.
Such an outcome would, in Capurso’s view, see the Australian dollar appreciate by more against the yen than against the US dollar and other cross rates, an outcome that would suggest the yen will remain the currency of choice for those looking to put on the “carry trade” to take advantage of interest rate differentials.
