Forex Risk Appetite Definition
Concept of Yen Carry Trades
Yen carry trade
Yen carry trade – involves the Japanese yen at low interest loans (0.5%) to finance purchases of high-yielding assets. The investor earns the difference in interest rates or "take" as long as interest rates rise in Japan (Increases borrowing costs) and exchange rates are stable (exchange rate risk if the yen appreciates).
To explain briefly the process, the Japanese yen is borrowed at interest rates very low. The yen are sold to buy a stronger currency. The new currency can be used to buy assets in high yield. At the time to relax the trade, the asset is sold for principal and interest on the underlying currency, which in turn is sold to buy yen and repay the loan called yen.
This trade can be covered by about 100 basis points (1%), so if an investor borrows Japanese (@ 0.5%) and invests in U.S. Treasures in 4.5%, clearly wins 300bp (3%). The yen carry trade has been like a continuous money generating opportunity for big investors. Billions of dollars are estimated to in this trade, which has actually been profitable for investors.
Implications of Yen carry trades
Rising asset prices high performance which investments are being made.
The weakening of the yen as investors increasingly turn to yen carry trades, in turn make more profitable trades.
The increase in risk appetite of investors has seen yen loans for investment in emerging economies like China and India. further magnified leveraged trades of the benefits and risks. Currently the New Zealand dollar and Australian dollar are high-yielding currencies while the Japanese yen and the franc Swiss are the most popular currency loans due to low interest rates.
The yen has been weakening against the dollar in the last two years. However, the recent appreciation of the yen has been the correction of yen trades. In addition, the unexpected growth of 4.8% in the Japanese economy in the fourth quarter of 2006 will force central bank to raise rates. Japan's short-term interest rate was 0% in 2001 to July 2006. This rate increased 0.25% in July 2006 and subsequently increased to 0.5% in February 2007. The increase in interest rates has increased the cost of borrowing that speculators yen. This, coupled with the recent appreciation of the yen has left two exit routes for traders – lost book squaring positions or trade coverage from swaps.
India and the yen carry trade
Several investment funds in India have raised money for the Japanese market, for example, Fidelity Investments, Deutsche Asset Management and several others. Japanese currency has also entered the Indian market throughout Japan and other investors are borrowing yen to invest in Indian asset classes, companies and funds loans denominated in yen.
Excess of hedge funds in the economy, caused in part by the yen carry trade, have increased the inflation rate to 6.7% and may lead to overheating of the economy.
Unwinding of Yen Carry Trades
The recent appreciation of the yen forcing traders to sell assets and borrowed yen to pay, leading to a fall in asset prices and a further strengthening of the yen.
In October 1998, a massive cancellation of yen carry trades lead to excessive volatility in financial markets. During that period, the yen had been depreciating in three years. Mid 1998, the yen began to appreciate ultimately leads to a mass sale of high-yielding assets and currencies underlying repay loans denominated in yen. This led to a sharp appreciation of the yen (due to bulk buying yen for reimbursements) and also led to a sharp fall in prices of high-yielding assets (Due to bulk sale). The Federal Reserve was forced to reduce the rate of food two times to market liquidity.
At present, hedge funds with low exposure to currency carry trades against in 1998 when the yen carry trade is a very popular strategy for hedge funds. In general, the current level of yen carry trades seem lower than during the period of 1998, even so, a possible future mass reversal of yen carry trades would most definitely can create instability in the markets. For an Indian investor, this is just one of the unexpected effects of increasing globalization!
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