Carrying Yen
March 7th, 2007 by Grant in: Economics, InvestingThe yen carry trade has been a hot topic recently, both in the global markets, and thanks to Winston, on this blog as well.
To preface this, it is widely assumed that the unwinding of the yen carry trade is what’s prodding the bears to pinch-hit for the bulls in markets all over the world.
So I thought I’d do a little research on just what exactly a “carry trade” is.
Carry trades refer to the practice of investors borrowing in a low-yielding currency, such as the yen, and reinvesting in higher-yielding currencies and assets, such as, well, anything carrying a higher yield than the yen. Effectively, if another currency is more valuable than the yen, you’d borrow yen at a low interest rate and buy the other currency.
Where the bear meets the bull is when the yield on the yen actually increases, thereby making the spread between other currencies smaller, and the concept less attractive. All of a sudden, you’ve got loans coming due on the yen, meaning you’d have to sell your other assets to pay off the loan, hence a massive sell off in nearly everything.
The most popular currency to borrow as of yet has of course been the yen, however the Swiss franc also shows a similar financial trait. Many people (or firms for that matter) are reinvesting their yen in high-yield currencies such as the New Zealand dollar, the British pound and the South African rand.
“The almost-free borrowing costs of the yen have also been responsible for financing massive bets in a variety of high-risk markets such as commodities and emerging markets. The carry trade is expected to be reversed as the Japanese economy strengthens and prices begin to rise.” -Source
While this should be an eye-opener to those who think the local economy is the driving influence behind how well their investments do, I also think that the fundamentals of many (or most) American companies are still in tact.
However, a pending wide-spread credit problem stemming from sub-prime lending may have a more sweeping effect on stocks than many people realize.
Leave comments
Subscribe to Comments
Loading ...
March 8th, 2007 at 9:34 pm
Nice write up Grant. It should be noted that this yen carry trade is still attractive to many people, given that the Japanese rates are still sub .5% and their rate policy-makers have said they have no plans of aggresively raising the rates. Also, this carry trade certainly isn’t the sole catalyst for the recent volatility, but if you’ve got a yen ticker next to your Dow or S&P ticker you should see some relationships…yen rallies S&P falls, yen drops, S&P rallies.