A popular yen-centered carry trade that blew up spectacularly two weeks ago is staging a comeback.
Japan’s currency has weakened more than 5% against the dollar since Aug. 5, when a cocktail of hawkish Japan monetary policy moves, jitters around US earnings and a feeble jobs report catapulted the yen to a seven-month high.
Nomura Holdings Inc., Japan’s biggest brokerage, has seen a variety of investors start borrowing the yen again to invest the proceeds elsewhere in higher-yielding assets. It suggests corporate clients and hedge funds, who have been enthusiastic carry traders, are getting back into those deals.
“There has been a notable move back” into carry trades after US retail sales data beat estimates, said Antony Foster, head of Group-of-10 spot trading at Nomura in London. Multiple accounts have sold yen to buy the Australian dollar and sterling, he said.
US bond yields rose Thursday after the sales data spurred traders to dial back their expectations for Federal Reserve interest-rate cuts this year. Higher yields in the rest of the world amplify the appeal of borrowing cheaply in yen, where interest rates are far lower, to invest in assets overseas.
The move back into carry trades highlights the allure of the strategy even after the volatility seen in recent weeks. The yen gained on Friday, paring its worst weekly drop in almost two months, down more than 1% against the dollar.
Traders had wagered billions of dollars that the yen would weaken, only for the currency to jump last month and crush such positions. Fueling the popularity of the trade in the past were expectations that the Bank of Japan would keep interest rates at rock bottom levels as it had for two decades, but its two rate hikes this year to fight emergent inflation have shown the dangers of the strategy.
ATFX Global Markets, an Australian online forex broker, has seen around a 30% to 40% rise in yen shorts in the past week, with a big chunk of the bets driven by hedge funds and high net worth investor clients.
“People have pretty short memories,” William Vaughan, associate portfolio manager at Brandywine Global Investment Management, said of the carry trade and investors who ply them. “There’s so many momentum traders in that sort of space.”
One of the key questions for investors still sitting on the carry-trade sidelines is whether the Bank of Japan will hike interest rates again this year. BOJ Deputy Governor Shinichi Uchida has already indicated that policymakers won’t raise rates further if financial markets are unstable.
BOJ Outlook
If the BOJ holds fire, then the allure of re-entering the trade is poised to grow.
Traders may get further clarity on the trade this coming week with BOJ Governor Kazuo Ueda due to speak before parliament on Aug. 23. They may also be emboldened if Federal Reserve Chair Jerome Powell, in his Jackson Hole speech due the same day, pushes back against bets by some traders that the US central bank will ease monetary policy by half a percentage point in September.
If Ueda sounds dovish while Powell appears hawkish sounding, that should keep interest rate differences between the US and Japan elevated, enticing more investors to enter carry trades.
Among those shorting the yen now is Calvin Yeoh, who helps manage the Merlion Fund at Blue Edge Advisors in Singapore.
The fund is “still short,” said Yeoh, a money manager at the hedge fund who entered a bearish yen trade against the pound earlier this week. “We’ll try and ride this back up to pre-BOJ levels if the trend allows and volatility continues to settle into prior ranges.”
"Mary Nicola, Markets Live Strategist: “Global central banks are now shifting toward easing, barring the BOJ which will still keep rates low relative to peers. That means the carry trade is poised to make a comeback, provided that equity markets and the Chinese currency remain stable.”
The yen has slid to around 148 per dollar since touching 141.70 on shifting Aug. 5, but investors still remain cautious about selling the Japanese currency given its sudden surge earlier this month. “The big over-hang short yen position has been wiped out, but this market is extremely fragile,” says Foster at Nomura.
The fragility was evident in the latest Commodity Futures Trading Commission data, which showed speculative traders pulling back sharply on bearish yen bets during the week to Aug. 6.
Even if comments from Ueda and Powell pave the way for investors to buy dollars for yen though, that doesn’t mean they will all rush to do so.
M&G Investment Management, which has pared some bullish positions on the yen, says that while the currency is undervalued, it might remain so for a while yet.
Japan’s currency “is really cheap, but we’re not foolish enough to think that it is going to ping back down to fair value anytime soon,” said Jim Leaviss, one of Britain’s most well-known bond investors and head of fixed income at M&G.
For Nick Twidale from ATFX, there’s already evidence that investors are reloading yen shorts as part of their strategy to buy higher-yielding assets. “The carry trade is still very relevant,” said the chief analyst in Sydney.
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