Japanese boom may put paid to yen carry trade

MUMBAI: The spectre of another round of unwinding of ‘yen carry trade’ in the next few months is raising its hood again. The key reason behind this fear is expectation that the Japanese yen may appreciate against the dollar in the next few months, amid likely rate hikes by Bank of Japan and the sustained growth of the Japanese economy.

Carry trades involve borrowing funds at low interest rate currency and earning profit out of investing these proceeds in overseas assets with higher returns. In Japan, investors took advantage of the near-zero interest rate in the past many years by borrowing yen, converting them into dollars and investing in higher-yielding assets, including overseas equities. They make a neat profit, when they book profits and buy back the yen. So, when the yen appreciates against the dollar, investors have to shell out more dollars to buy yen, thereby affecting returns.

UK-based Hanover Square Capital’s CEO, Arvinder Sood, who has spend over a decade in Japanese financial markets, said, “If the yen strengthens consistently against the dollar, global asset prices will correct across geared or levered asset classes. Some hedge funds will be forced to unwind their positions.”

The impact of liquidation of yen carry trades, in part, on global equities, including Indian, was recently seen in February, when most markets tanked by 10-15% in a matter of few days. At that point of time, several emerging markets were at all-time highs and there were concerns about further jumps in global interest rates, which also prompted the unwinding.

Going forward, analysts feel the biggest trigger for a reversal of carry trade money to Japan would be a hike in interest rates there, led by stronger economic growth, which would lift the yen against the dollar.

ABN Amro’s senior economist, Gaurav Kapur, “speculations are rife that the Bank of Japan could hike rates in its August/ September meeting. The Japanese economy is showing signs of growth, as one can see from the GDP growth in last few years and mostly recently from the employment numbers.”

Japan has been a laggard in hiking interest rates compared to most other economies because of political pressures and that consumer price inflation is close to nil. Analysts feel the current weakening of the yen against the dollar could be temporary.

“One also needs to consider that the dollar is more likely to weaken, not only against the yen but also other currencies. Also, the dependence of the Japanese economy on the dollar itself is declining,” a senior treasury official said. But, not all agree that the yen may appreciate consistently against the dollar in the next few months.

A treasury manager with a private sector bank said, “While the Japanese economy has shown successive quarters of growth, the currency still has a weakish tinge attached to it. Only if there are rate hikes announced, will the positive outlook for the economy get translated into a stronger currency.” Some analysts expect the yen carry trade to continue, given that emerging market equities continue to offer better returns.“Even after calculating the cost of carry trade and forex risks, emerging markets still offer a good value proposition for investors (using carry trade),” said Firstcall India Equity Advisors’ country head, VVLN Sastry.