Forex : Slight Unwind in Yen Carry Trade

Last week witnessed a sudden unwinding in the yen carry trade, as a global market downturn affected investor sentiment towards risk. Volatility is the only market force that could seriously contend at collapsing the carry trade, and last week produced significant volatility. All of the world’s majors fell against the Yen, namely the New Zealand Kiwi, which fell by 7.5%. The kiwi, you may recall, has been one of the main currencies on the other end of the carry trade, due to its high interest rates. However, analysts are reluctant to proclaim an outright end to the popular carry trade, preferring to wait and see how volatile the world’s capital markets appear in the coming weeks. The Financial Times reports:

The wave of risk reduction also prompted investors to take profits in the Australian and New Zealand dollars, which have surged this year from central bank credit tightening or expectations of more tightening to come.

Yen retreats as stocks firm up

By Reuters Jul 30 10:26:23

The yen slipped from three-month highs against the euro and the dollar, while the high-yielding Australian and New Zealand currencies reversed earlier losses on Monday as firmer stock markets calmed investors’ risk aversion.

Concerns that troubles in the high-risk U.S. subprime mortgage sector will spill over into the wider credit markets and beyond the United States have led to volatile trading in recent sessions as banks’ risk aversion gauges jumped to multi-year highs.

But European stock markets managed to stage a recovery on Monday even as German industrial bank IKB cut its earnings target citing subprime devlelopments.

In foreign exchange markets, this made investors more willing to take risk by re-entering carry trades where low-yielders like the yen are borrowed to fund higher return investments in places like Australia, New Zealand or Britain.

”U.S. equity futures are rather better this morning, European markets are also better and credit spreads seem to be tightening a little bit. For the moment at least, calm is returning to asset markets and that’s making carry look more attractive,” said Adam Cole, senior currency strategist at RBC Capital Markets.

By 0900 GMT, the New Zealand dollar was steady at US$0.7647, recovering from a one-month low of US$0.7563 posted in Asian trade. The Australian dollar was up 0.2 per cent versus the greenback after posting its biggest weekly decline in 2-1/2 years in per centage terms last week.

With no first tier data on either side of the Atlantic on Monday, analysts said trading was likely to remain volatile, charting the ups and downs of news from the credit sector.

The euro was up 0.3 per cent against the yen at 162.26 yen, rallying back from a three-month low earlier on Monday of 160.67 yen, according to Reuters data. The dollar was up 0.1 per cent against the yen at 118.75 yen, also bouncing back from an earlier three-month low.

The yen broadly shrugged off a crushing defeat for Japanese Prime Minister Shinzo Abe’s ruling camp in upper house elections on Sunday that threatened policy gridlock, with the conservative leader vowing to stay in his post.

The recent gains in the Japanese currency and weakness in the high yielders made current levels attractive for re-establishing carry trades, traders said.

The euro was up 0.2 per cent against the dollar at $1.3660, while sterling was up 0.1 per cent at $2.0258.

While credit worries will dominate sentiment, there’s a heavy data flow this week too. July non-farm payrolls, global purchasing managers’ indices, the Chicago PMI and interest rate decisions from the European Central Bank and Bank of England could all move currencies.

The ECB and BoE are expected to keep rates on hold at 4 per cent and 5.75 per cent, respectively, although both are still seen raising rates at least once more this year.

”A deteriorating growth outlook is perhaps the most serious risk to the risk appetite environment and this is more likely after last week’s extremely poor U.S. housing data, so this week’s regional PMIs and non-farm payrolls report will be important,” wrote RBS strategists in a client note on Monday.