Master Rider Blog

Yen Carry Trades

August 24th, 2007 NW Teong

The logic of Yen carry trades is very simple: borrow Yen at a low interest rate and buy currencies that give you higher interest rates or simply invest in assets that give you a higher yield. You make money provided the exchange rate of the currencies involved is stable. Of course, you make more if the exchange rate moves in your favour (however, this is not the primary objective of a Yen carry trade).

I have cautioned readers to watch out for signs of unwinding of Yen carry trades back on 10^th of Aug (refer my blog on “How to Tame Market Volatility?”). I mentioned in that blog urging readers to watch out for liquidity which could suddenly dry up due to negative impact of sub-prime loans which of course have caused some heavy redemption of funds, unwinding of Yen carry trades. I also urged readers to watch out on the weakness of regional currencies (this is so as Yen carry traders reverse out their trades, for instance, instead of buying the NZ dollars, they are selling NZ dollars to close their positions).

Interestingly to note, Yen carry traders do not like extreme volatility. Any such event will force them to quickly unwind their positions which we have witnessed for the whole of last week. There is report that at end of last week (17 Aug 07), Japanese individuals alone closed out about US$30b in carry trade positions. After last week turmoil, the markets seem to be relative calmer now.  The exchange rate looks conducive once again to conduct the Yen carry trades.

At the peak of last week’s market turmoil, the Yen hit 114 against one US$. If you look at the chart below, at 114, the Yen is quite near to its two year high of 110 against US$. Please note that the lower the reading in the chart means higher strength for Yen.

Yen/US$ Chart: Courtesy of Yahoo Finance

In short, with the strength in Yen, Yen carry traders can buy even more foreign currencies and thus enjoy higher expected returns  (in terms of higher yield) if Yen is weakened when they closed their carry positions (and in terms of better foreign exchange rate).

Obviously, Yen carry traders have to pay close attention to the interest rate policy by the central bankers of the relevant countries, namely Japan, US, China and the countries which currencies / stocks or any other assets that they intend to invest. In addition, they have to monitor all major events that may have a huge impact on their trades. In a way, this is no different to stock investors. We have to know what will impact our share price, our investments too!

As a stock investor, we have to be mindful of what these Yen carry traders do. A big unwind of their positions will cause major turbulence in various assets classes in the region. The reason is simple, this Yen carry trades has provided ample liquidity as they borrow yen to invest in all kind of assets (e.g. currencies, stocks, bonds etc) in the world, especially in Asia!

Cheers!

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Entry Filed under: Macro, Stocks