Volatility levels on JPY/AUD forward contracts recently jumped to 25%, the highest level since the Asian financial crisis of 1997-1998.  Combined with other factors, this suggests that the JPY/AUD carry trade, whereby investors borrow in low-yield Yen in order to invest in high-yield Australian Dollars, may be coming to an end.  Economic indicators show a faltering Australian economy, sagging confidence, and a record trade deficit.  Meanwhile, inflation has moderated, such that it is unlikely that the Royal Bank of Australia will hike rates any further and enhance the nation’s comparatively attractive yields.  Even though the interest rate differential between Australia and Japan remains a healthy 6.75%, investors may deem this inadequate compensation for the risk implied by weak economic fundamentals. Bloomberg News reports:

"For the next one or two quarters, the Aussie’s fundamentals will probably look very soggy. I would suggest the Aussie dollar is expensive. There has been a stunning shift back in favor of the yen," [said one analyst].

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