USD/JPY Hit By Unwind

One of the most prominent global carry-trades is flashing a strong warning sign to anyone willing to watch.  The Yen carry-trade rose to prominence in the early 2000s as the Bank of Japan was forced to keep cutting rates to avoid deflation, a process that failed to yield results for the Japanese economy.  However, ultra-low borrowing rates did benefit one group of individuals; investors.  Traders were able to take advantage of the low interest rates by borrowing Yen to invest in other higher yielding assets.  Low interest rates also ensured that the Yen would stay weaker and help bolster Japanese exporters.  However, now that the global export economy is collapsing at a near record pace, one of the first areas this shift in fortunes is evident is the Yen carry-trade.

The Fundamental Picture

In the wake of the last financial crisis, the Yen was one of the biggest gainers owing to investors unwinding exposure to carry-trades in 2008 and 2009.  Then came the Tsunami which destroyed the reactor at Fukushima, around the same time as the Yen hit multi-decade highs, crushing the nation’s exports and harming output.  However, coming to the rescue was former Prime Minister Shinzo Abe, promising to get Japan Inc back on track.  His first move when reelected was to install a new central bankers with an affinity for his own self-styled version of policies referred to as Abenomics.  The premise of this new monetary and economic program was reversing the steady decline of nearly two decades of deflation.  Wages had stagnated and moreover, exporters were crushed by the stronger Yen. 

The strategy, in coordination with the Bank of Japan, called for expanded quantitative easing that would focus on the bond market and would later also include a wider berth of assets including real estate investment trusts and equity futures.  The kneejerk reaction was a net positive for the Japanese economy, helping exporters to rebound and enabling the Bank of Japan to meet inflation targets.  At the outset, it was also great for carry-traders.  Japanese interest rates were not set to move and the Yen had climbed to such heights that carry-traders who got in early were unconcerned by the fluctuations in the USDJPY pair, as long as it moved higher. However, recently, the carry-trade has lost a lot of enthusiasm as volatility picks up and Central Bank omnipotence is questioned.