Carry Trade Under Pressure

The Yen is rising once again, as another set of investors unwind their carry trade positions. No, it wasn’t the threat of higher borrowing costs, via a hike in Japanese interest rates, that spooked investors. Rather, it was general volatility in forex markets that jolted investors to re-assess their short positions in the Yen. Volatility is anathema to carry traders, as shorting a currency is similar to shorting a stock. Once any security that one has shorted begins to rise, short sellers are pressured to ‘buy to cover’ which only sends the currency higher and triggers further buying to cover. This phenomenon is known as a ‘short squeeze’ and seems to affect the Yen every time volatility surfaces. The Financial Times reports:

Analysts said the resulting rise in risk aversion had led investors to exit carry trades, in which the purchase of riskier high-yielding assets is funded by selling low-yielding currencies such as the yen.

 
Read More: Investors exit from carry trades