- Money Morning Australia

The Yen Carry Trade is Back, But With a Difference


Written on 04 February 2013 by MoneyMorning

yen carry trade

Japanese Prime Minister Shinzo Abe and his government’s success in jawboning the yen lower against the U.S. dollar have revived an old hedge fund favorite – the yen carry trade.

A carry trade is when an investor borrows a currency with low interest rates, such as the yen, and uses it to buy assets in another currency with a higher interest rate, such as the Australian dollar.

The yen carry trade had fallen out of favor with traders after the ‘Lehman Shock’ of 2008 as governments attempted to deal with the financial crisis by cutting short-term interest rates and initiating successive rounds of quantitative easing.

In the post-Lehman world, global interest rates converging on zero and massive balance sheet expansion by central banks to combat sluggish economies and deflation have become the norm.

As a result, the yield spread between the currencies being borrowed and the currencies being used to purchase higher-yielding assets has fallen, making the trade riskier and less attractive.

Now that the new Abe government in Japan has succeeded in talking the yen down to two-and-a-half year lows and seems to be looking to push the yen even lower, traders are once again using short-term yen borrowings to fund short-term purchases of assets in other, high-yielding currencies such as the Norwegian krone or the perpetual favorite, the Australian dollar.

‘Using the lowest yielder, the yen, to fund purchases of the Australian dollar could generate a 3% annual yield spread, without leverage and before the expenses of any investment fund used to put on the trade,’ writes Hamlin Lovell in the CFA Institute’s Inside Investing publication.

And David Harden, senior commercial dealer at Global Reach Partners, told CNBC Europe, ‘Not only is the yen losing ground because of Abe’s comments and monetary policy. But also, we’re seeing risk appetite improving across the globe and so the yen is weakening because it was a safe-haven currency and now it’s being sold because people are buying risk again.’

Dangers of Reaching for Yield

Of course, the real question is: How much risk are traders willing to take on?

The monthly volatility of the Australian dollar/yen cross is 4.91%. Is it really worth risking 4.91% a month in order to gain 3.0% a year in excess yield?

It is only if you think the Australian dollar is going to continue to strengthen against the yen. In that case, an investor would make a lot more money from the appreciation of the Australian dollar against the yen than would be made from the higher yield paid by Australian dollar assets.

The problem with carry trades is that they tend to get very popular among the banks and hedge funds that trade them. History shows that these trades tend to move in only one direction as everybody jumps aboard the bandwagon.

This makes the yen carry trade extremely dangerous because interest rates in the three largest economies in the world – the U.S., Europe and Japan (China is excluded because its currency does not trade freely) – are all converging on zero.

Everyone is looking for a few extra basis points. Everyone is taking a lot of extra risk for the small extra returns they can get.

And it will all be OK until, one day, it isn’t. That’s what makes this latest iteration of the yen carry trade so dangerous.

Jeff Uscher
Contributing Writer, Money Morning

Publisher’s Note: This article originally appeared in Money Morning (USA)

From the Archives…

Make Sure You’ve Updated Your ‘Stock Insurance’ Policy
1-02-2013 – Kris Sayce

Here’s Why We’re Still Buying This Stock Market
31-01-2013 – Kris Sayce

Revealed: Inside the Mind of a Share Trader
30-01-2013 – Murray Dawes

Buy Silver – the War Against the China Bears Begins
29-01-2013 – Dr. Alex Cowie

China’s Economy: Enter or Exit the Dragon?
26-01-2013 – Callum Newman


Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


TESTIMONIALS

"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery

How Money Morning Can Help You Become a Smarter, Better, Investor
Diggers and Drillers – oil rush
Blue Chips
Latest Stock Market Updates
  • ^NDX4012.268+62.681 - +1.59%
  • ^FTSE6389.89-29.26 - -0.46%
  • ^AORD5399.300+29.400 - +0.55%
  • ^AXJO5412.200+29.100 - +0.54%
  • AUDUSD=X0.8788
  • USDJPY=X107.945
Gold Stocks leadgen
NFI Megatrends – birthed stock gains
The last investment megatrend birthed stock gains of 11,095%, 20,621% and 50,760% over 20 to 40 years.

If Kris Sayce is right, gains from this next megatrend won’t just reach those heights...

They’ll SURPASS them..
To see why, click here.
Resource sector leadgen
ASI – intercept banner 220
Iron ore leadgen
Investing Success leadgen