Word around the streets is that the famous yen carry trade is about to stage a major comeback! Will traders return to the ol’ strategy, or will it tank deeper than Charlie Sheen’s attempts at “winning”?
For y’all who have been living in a cupboard under the stairs (oh wait, that’s Harry Potter), carry trade is simply the strategy of borrowing cheap currency in order to buy one that has bigger yields.
For example, Harry Potter borrows 1 million GBP from Dumbledore at an interest rate of 1%. Using his money, Harry Potter buys Hogwarts and then rents it out for vacationing wizards at an annual rate of 6%. Since Harry is only paying 10,000 GBP a year while receiving 60,000 GBP, he pockets the 5% interest rate differential of 50,000 GBP!
The same principle holds true for currency trading. Traders usually sell low-yielding currencies and buy high-yielding ones in order to benefit from interest rate differentials. But even though it’s tempting to sell the Greenback with the Fed‘s interest rates below 0.25%, traders usually sell the uber low-yielding yen. After all, you can hardly get any more rock bottom than the BOJ‘s close to zero interest rates!
I know, I know, I’ve talked about the return of carry trade ages ago, but here’s why I think yen carry trade is coming sooner than a Rebecca Black-Justin Bieber mash-up:
First is the expiration of QE2 in June. From what I’ve heard, the Fed could hit the brakes in providing the economy with stimulus. If this turns out to be the case, the U.S. will be a step ahead in adopting a tighter monetary policy, leaving Japan with the lowest benchmark rate.
Naysayers are also anticipating that the BOJ will announce more stimulus measures in its policy statement tomorrow. Tankan survey responses gathered after the earthquake showed that the outlook of manufacturers is pretty gloomy in the coming months. Poor economic prospects could weaken the yen further, and make it more appealing as a funding currency.
Lastly, there’s also the G7‘s promise to help the BOJ weaken the yen. The clique might not have publicly pledged to step in to the currency markets whenever Japan sends an S.O.S., but I betcha there are a handful of traders out there who are still haunted by memories of getting their accounts burned for buying the yen despite talks of an intervention.
Is it safe to say that selling the yen is the way to go?
Don’t get all your hopes up yet. Here are some signs that say yen carry trade won’t last long.
First, there’s the impact of repatriation efforts, where insurers cash in on their overseas investments to cover disaster-related costs. Several analysts estimate that repatriation could reach roughly 10 trillion JPY in yen-buying, which could provide support for the Japanese currency.
In addition, more and more investors are purchasing Japanese stocks, betting that the prices will be back to pre-quake levels soon. You see, most investors are bargain hunters. They go in a buying frenzy when assets are cheap, just like Happy Pip goes gaga when there’s a half-price sale on boots!
In this case, since Japanese equities reached record lows after the disaster, plenty of investors grabbed the opportunity to “buy low” then eventually “sell high,” just as Warren Buffet does it.
Heck, even Warren Buffet himself is bullish on Japanese stocks, along with Jim Rogers, co-founder of George Soros’ Quantum hedge fund. Both hotshot investors believe that Japan will be able to get back on its feet really soon, and that the recent dips in the yen and Japanese equities present easy profit potentials.
So, which side are you on? Vote in the poll or let us know what you think by posting your comments below!