The yen strengthened to its highest level in seven months, shaking up the yen carry trade after cross-border yen borrowing surged to $2.34 trillion amid expectations that the Bank of Japan (BOJ) is poised to raise interest rates.
On September 9, 2569, at 15.02:7 PM, Reuters reported that the Japanese yen's appreciation to its highest level in seven months is leading investors to question whether this could be the beginning of the end for the Yen Carry Trade, a long-standing investment strategy that has played a significant role in global financial markets.
Pressure on the Yen Carry Trade has increased due to expectations that the Bank of Japan (BOJ) may accelerate interest rate hikes, with the next rate cut potentially occurring as early as next week's meeting. This would raise the cost of borrowing yen and reduce the attractiveness of investing the yen in higher-yielding assets.
What is Yen Carry Trade?
Carry trade is a strategy where investors borrow money in a low-interest currency, such as the Japanese yen, and then use that money to buy currencies or assets that offer higher returns, such as the US dollar, Mexican peso, New Zealand dollar, and other emerging market currencies.
The yen has been one of the main currencies used as a funding source for carry trade for many years. Because Japan has pursued a low-interest rate policy for an extended period, investors can borrow yen at a low cost before investing it in bonds or other assets that offer higher returns.
Upon completion of the investment, which is typically a short-term investment, investors will sell the assets or exchange the money back into yen to repay the loan.
The annual return on a Dollar-Yen Carry Trade is typically around 2.5-3.5%, based on the interest rate differential between the US and Japanese interest rates, and investors can further profit if the yen weakens during the holding period.
However, these returns have decreased significantly compared to 2567, when this strategy generated returns of approximately 5-6%.
Investors are beginning to use the Swiss franc instead of the yen.
Following Japan and the United States' intervention in the market by buying yen in late July, investors using carry trade strategies are showing signs of shifting to the Swiss franc as an alternative currency for fundraising.
The Yen Carry Trade, in its current form and largely operated by foreign investors, has expanded significantly since 2556 under the government of former Prime Minister Shinzo Abe, when Japan implemented quantitative and qualitative monetary easing policies while US interest rates rose and the yen weakened.
This strategy expanded significantly again during 2565-2566 when the U.S. Federal Reserve (Fed) accelerated interest rate hikes to control inflation, while the Bank of Japan (BOJ) kept short-term interest rates negative. Coupled with a sharp depreciation of the yen, this widened the yield spread between Japan and other countries.
How big is Yen Carry Trade?
The true size of the Yen Carry Trade is unknown because much of the investment position cannot be directly verified. However, there are some data sets that can be used to estimate the size of the market.
Jefferies analyzed data from the Bank for International Settlements (BIS) and found that cross-border yen borrowing reached a record high of 360 trillion yen, or approximately 2.34 trillion dollars, as of March. This represents the largest accumulation of carry trade-related positions in three decades.
Another indicator is the betting position on a yen weakening. Data from the U.S. Commodity Futures Trading Commission (CFTC) shows that as of the week ending September 1, investors had a net short position of 92,227 yen contracts, an increase for the third consecutive week, but still below the two-year high of 163,412 contracts reached in the week ending July 1.
The true size of a Carry Trade position may be higher than what the data reflects, because hedge funds and computerized trading funds often use leverage to inflate the size of their investments.
How is this different from the Carry Trade crisis of 2567?
No matter how large the Yen Carry Trade, if investors suddenly close their positions all at once, it can have a severe impact on global financial markets.
A similar event occurred in July 2567 when the BOJ surprised the market by raising interest rates, causing the yen to appreciate rapidly from approximately 154 yen per dollar to 141 yen per dollar within just a few days.
Investors who used the yen as a source of funding were forced to close their carry trade positions, resulting in continued selling pressure in stock markets worldwide. The Japanese stock market was particularly hard hit, with the Nikkei index plummeting 12.4% in a single day.
However, there is no sign that the current situation is repeating the events of 2567, as BOJ officials have been signaling for weeks that interest rate hikes are imminent and that further increases may be necessary in the future.
The stock market has therefore been relatively well-positioned to handle both signals of tightening monetary policy and the appreciation of the yen. Analysts point out that the yen's movements so far have been orderly, reflecting investors gradually adjusting their positions and outlooks in anticipation of the crucial BOJ meeting next week.
Reference: reuters.com
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