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."
yen carry trade collapse