Ready for a Yen-Carry-Trade Rebound? New Year Brings Mixed Signals
By Martin Fritz, Tokyo
Japans currency, the Yen, potentially facing another volatile ride?
Get ready, markets! The humble yen could make a comeback as the financing currency of choice for traders seeking speculative returns—but don't count on it just yet. Here's what you need to know.
The yen is the third most traded currency on the foreign exchange market and the fourth most important reserve currency in the world, trailing behind the dollar, euro, and British pound. For two whole decades, it has been the go-to currency for carry trades due to Bank of Japan's (BoJ) zero-interest-rate policy. Simply put, investors borrow yen at minuscule interest rates, exchange them for dollars or emerging market currencies, and invest in high-yield assets, like US tech stocks or emerging market bonds. If the yen gains strength, traders quickly close their positions to avoid heavy losses. So, will we see these carry trades regain momentum in 2023?
Economics 101: Understanding Carry Trades
Here's a quick refresher on carry trades: essentially, investors look for profit opportunities by borrowing currencies with low interest rates and investing in assets with higher returns. In the past, the yen has been an ideal financing currency due to its low interest rates, enabling investors to reap higher yields on their investments elsewhere. However, the rising tide doesn't always boost carry trades—as we'll see, several factors can influence the dynamics of this trading strategy.
The Yen's Ebb and Flow: A Look at Key Factors
Sway of Interest Rates
Analysts predict that the US dollar-Japanese yen (USD/JPY) exchange rate will experience some turbulence, hovering around the 145–148 range in April 2023. This volatility is a response to softening US economic growth and stronger Japanese data. Meanwhile, experts anticipate a gradual yen strengthening, with values ranging between 110–120, as the Federal Reserve potentially slows down its interest-rate hikes, and the BoJ adjusts its yield curve control policies.
Safe Haven Demand
Recent yen strength has been partly due to global risk aversion, with investors treating the yen as a safe haven, despite its traditional carry-trade status. Remember, in times of uncertainly, the yen tends to appreciate.
Market Sentiment and Liquidation
Contrary to popular belief, there's been limited large-scale unwinding of carry trades. Although yen futures have seen increased purchases, this has not resulted in a wave of capital outflows. Shinhan Investment has observed moderate liquidation of Japanese funds in high-yield currencies but nothing that indicates a crisis.
The Outlook for Carry-Trade Momentum
While a strengthening yen naturally poses a threat to carry returns, the persistence of rate differentials, while narrower, and lower overall volatility compared to previous years might still allow for certain carry strategies. Investors may gravitate towards shorter-term positions to manage geopolitical and policy risks, rather than engaging in the long-term multi-year carry trades that we saw before.
So, What's the Final Call?
When it comes to yen carry-trades, the new year may bring selective opportunities for traders. But a broad-based resurgence of these trades is unlikely unless the difference in interest rates between the US and Japan takes an unexpected turn for the wider. So, as always, keep your eyes peeled, your portfolio poised, and your risk management razor-sharp. Happy trading, folks!
Investors may consider yen carry-trades in 2023, given the potential for slight interest rate differentials between the US and Japan. However, a significant rebound in yen carry-trades might remain unlikely due to the BoJ's adjustments in yield curve control policies. Concurrently, investors should be cautious in their asset allocation, considering market volatility and the yen's status as a safe-haven currency.
