šÆšµ THE TRUTH ABOUT YEN CARRY TRADE IN THE CURRENT CONTEXT
šø With the Bank of Japan signaling a potential interest rate hike this week, concerns about yen carry trade have resurfaced.
šø Yields on 10-year Japanese government bonds are at their highest level in 18 years, yet the yen remains weak. This suggests that carry trade persists. While JP Morgan estimates that over 50% of yen carry trade closed last year, some analysts suggest that approximately $500 billion in yen-backed carry trade still exists.
šø Yen carry trade is a strategy of borrowing yen at low interest rates during periods when Japan maintains low interest rates, then investing in higher-yielding assets such as US stocks, emerging markets, and cryptocurrencies. When Japanese bonds pay higher interest rates than before, money is no longer forced to flow overseas to seek yields as it once was.
šø It's true that Japanese interest rates are still much lower than US rates, so the likelihood of a widespread carry trade liquidation is low. However, the real risk lies in the decrease in demand for US bonds, forcing US bond yields to remain higher to compete, thereby putting pressure on interest rates across the market.
šø Currently, the US 10-year yield is around 4.18%, much higher than the Japanese 10-year yield of around 1.96%. But when using a yen carry trade strategy, institutions must manage USD/JPY exchange rate risk, meaning they must hedge foreign exchange at a high cost, possibly around 2% per year, plus the risk of the Fed continuing to cut interest rates. After deducting hedging costs, the real yield is no longer attractive.
šø If the Bank of Japan raises interest rates more aggressively, the cost of borrowing yen will increase, and investors may rush to liquidate their positions. This week's rate hike was anticipated by the market, but the key factor remains the BOJ Governor's tone regarding further rate increases. Coupled with news that the BOJ is preparing to sell its previously accumulated ETF holdings, this is making investors more cautious.
