A borrowing strategy using yen unravels
tokyo -- Investors loved it. Central bankers worried about it. And though analysts could never measure its true size, most agreed it was a prime source of the cheap money that washed through global markets in recent years.
But with those markets now in turmoil, all of them are asking whether the yen carry trade is seeing its last days.
Over the last 10 years, the yen carry trade -- the practice of borrowing Japanese yen at almost zero interest and using that cash to finance higher-return investments mostly outside Japan -- became a favorite speculative tool of global hedge funds and small Japanese investors alike.
As the popularity of the carry trade grew, central bankers fretted that the availability of cheap yen was artificially lowering the price of risk.
The markets have now had a real-world look at what happens when that edifice of debt unravels. Turmoil in global markets in recent weeks had been encouraging investors to pull back, selling riskier securities and reducing the amount of money they owe. Last week, that gradual unwinding turned into a race among carry traders to sell non-Japanese assets and convert the proceeds back into yen to pay off their loans.
“Carry trades are coming unglued,” said Mark Cutis, chief investment officer at Shinsei Bank in Tokyo. “These are trades that everybody in our business knew were going to come unstuck.”
The days of the yen carry trade, he predicted, “are pretty much over.”
Initially, converting all that borrowed yen into other currencies depressed the value of the yen. Now, the repurchasing of yen has driven Japan’s currency up against the dollar -- at one point last week it was up 10% over its yearly low.
That kind of rise could have deep repercussions for Japan’s economy.
Japan’s steady if unspectacular economic recovery of recent years has been driven by export sales that are in part linked to the yen’s low value against the dollar and other currencies. A stronger yen means that Japanese exports become more expensive overseas.
Some analysts said they believed the carry trade was a valuable financial tool that would return once markets stabilized.
“When volatility gets high, the carry trade does not work,” said Tohru Suzuki, chief foreign exchange strategist at JPMorgan Chase Bank in Tokyo, who added that the size of the trade was even bigger than the available data indicated. But the volatility will eventually dissipate, he predicted, and when it does, “the carry trade will resume.”
In Japan, the debate over the future of the carry trade is partly a quarrel over whether traditionally cautious Japanese investors have developed an enduring appetite for risk.
To many observers, the Japanese -- especially older Japanese with substantial savings -- remain averse to taking chances with their investments. That view explains, in part, why there was a rush to convert investments back into yen last week: The currency is seen as a safe haven in times of volatile markets, and Japanese investors were with the pack that was fleeing the carry trade.
Recent surveys conducted by the Japanese government and the Bank of Japan also show that consumers here generally continue to be wary about their economic prospects.
But others contend that all the talk about the carry trade obscures a shift in attitudes among Japanese investors, who are increasingly eager to seek out foreign investments -- even risky ones -- to diversify their holdings and increase returns.
The Nikkei index was down 9% last week, including a 5.4% plunge Friday that was the worst single-day drop since the Sept. 11, 2001, terrorist attacks. Although Japanese stocks recovered this week (with the Nikkei recording its best two-day surge since 2004 on Monday and Tuesday), continuing market turmoil saw the yen continue to gain against all other currencies, a sign that no one was rushing back into the carry trade just yet.
“In the last 15 years, a new financial architecture has been constructed, and the results of this experience have been overwhelmingly positive for the global economy,” said Jesper Koll, president of Tantallon Research Japan, part of an Asian hedge fund.
“Now we’re having some market jitters, so we’re getting normalization.
“We just don’t know where normal is yet. That’s what the market is trying to find out.”
--
