Yen Carry Trade is Back, But with a Difference
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."
Why the Japanese Yen Has Triggered Global Concern
The Japanese government was criticized for deliberately weakening the Japanese yen by German Chancellor Angela Merkel during a question-and-answer session following a speech at the World Economic Forum in Davos, Switzerland.
"I can't say I'm completely free of worry when I look at Japan right now," Merkel said, according to Bloomberg News.
Michael Meister, a senior member of Merkel's Christian Democratic Union who will be meeting with Japanese officials next month, said in a telephone interview with Bloomberg, "What can Japan's competitors do? Either we're all smart and do nothing, or we follow suit and create a spiral that hurts us all."
"The Japanese economy's real problems are structural and beg structural remedies, not tampering with the exchange rate," Meister continued.
Merkel and Meister are not the only German critics of Japanese Prime Minister Shinzo Abe's program to revive the Japanese economy through weakening the yen.
Germany's Finance Minister Wolfgang Schaeuble raised concerns about excess Japanese liquidity flooding the global capital markets while Bundesbank President Jens Weidmann warned of politicizing the Japanese yen.
Meanwhile, South Korean Finance Minister Bahk Jae Wan said South Korean exporters, which compete directly with Japanese companies in many industries, including cars, electronics and engineering, might be "at risk."
Deng Yuhan, writing for China's Xinhua News, said, "The easing of Japan's monetary policy entails the weakening of its currency, a side effect – if not the purposeful design – that can translate into an artificial and unfair price advantage for Japanese exports."
Deng continued, "It is a safe bet that others would respond with driving their own currencies down, thus igniting a downward race among the world's most heavily traded media of exchange – known in a more dreadful way as currency wars."