FYI | Jan 31 2007
By Greg Peel
The yen carry trade has been with us for a long time, lingering in the back of the mind of many a market analyst or finance minister. While every now and again a warning call is made, to date there have been no noticeable ramifications, so complacency has ruled the day.
The yen carry trade (YCT) is the most exploited trade of hedge funds and general speculators across the global market. By borrowing in yen, one can invest in higher interest-paying currencies such as the US dollar or Australian dollar. In fact, everything from the Kiwi dollar to the Icelandic krona. As long as the relevant currency does not move too much, it’s a lock in profit.
There are grave concerns as to what might happen if the YCT were suddenly unwound, sometimes bordering on the hysterical (See “It’s The End Of The World As We Know It, If The Yen Carry trade Is Unwound, Sell&Buyology, 15/6/06). The last great debacle was the Russian crisis of 1998, which led to the demise of hedge fund LTCM, and resultant tumbling dominoes that threatened to bring down financial markets.
The Financial Times reports that according to Barclays Capital, the YCT has now reached its highest level since – you guessed it – 1998. US$34 billion, to be precise, calculated in 1998 prices for the yen, Swiss franc, sterling, and the Aussie.
The great fear is something will trigger an unwinding of the trade, and that a trickle would turn to a devastating flood.
That something may be close, some economists believe, as the yen has just fallen to four-year lows against the US dollar, and to a record low against the euro. Carry traders are suspected of having been the driving force. YCT concern reached fever pitch mid last year when it appeared the Japanese economy was on the turn and that the zero interest rate policy would be lifted. After a mild burst, Japan has failed to deliver much.
But the worry is now that the Japanese economy really is showing signs of improvement. This might be great if you’re Japanese, but it’s not much good if you’re short yen. A move up in interest rates could set off massive profit-taking before the honey pot empties. FT reports the CFTC has indicated short yen positions have reached a record level.
In 1998, the yen moved against the dollar from Y147 to Y112 in a matter of days. It is currently at Y122, and looking oversold.