Carry trade may buoy Yen

The Yen is rapidly approaching all-time lows (in real terms) against the world’s major currencies, and many analysts think they understand what’s behind this phenomenon: the carry trade. In a carry-trade strategy, investors will sell a currency that offers a low interest rate (with proportionately low borrowing costs) and will use the proceeds to buy a different currency that is supported by higher interest rates, effectively earning a return equal to the difference in rates. In the case of Japan, negative real interest rates have prompted many investors to short the Yen in favor of higher-yielding currencies, driving the currency to its current depths. However, analysts argue that a slight uptick in the Yen could drive many investors to quickly unload their positions (approximately $80 Billion outstanding), causing the Yen to appreciate. The Financial Times reports:

The potential of the carry trade as a source of future exchange rate volatility has brought back memories of October 1998 when the yen collapsed against the dollar as hedge funds unwound carry trades in response to the Russian financial crisis.

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