The Yen Carry Trade Isn't Dead

by: Bryan Moore

“When there is blood in the streets, it’s time to buy.” Obviously, this saying could not be any truer than the situation that investors all over the world are experiencing at the time of writing this post. Fear and risk grip the global marketplace in a way that hasn’t been seen since 2003. Investors everywhere should soon be taking advantage of the readjusted asset prices in all areas of the market, and because of this, I believe there will be a re-emergence of the carry trade that has been driving the currency markets over the past few years.

The currency carry trade involves the buying of high yielding currency, and the simultaneous selling of a low yielding currency. The idea behind this type of trade is that an investor looks to lend at the interest rate in the high yielding currency and finance or borrow at the low yielding rate of another currency. This is similar to the operations of domestic banks that “borrow” money from depositors, in the form of paying interest on a savings account, and then lend that money out to borrowers on higher-interest loans and profit from the spread between the two interest rates. The carry trade has been popular in the currency markets due to the amount of leverage available to traders who wish to exploit the spread between a high- and low-yielding currency pair.

Over the past few weeks, I have been bombarded through email, internet searches, newspapers, and TV media with articles proclaiming, “Unwinding of the Yen Carry Trade” and “Forex Carry Trade Unwinds Nearly 6 Percent, History Says it May Go Further.” The media obviously has done a great job at painting a gloom, and doom picture into the minds of the majority of the investors in the world. The market has now taken out the weak hands as well as the hands that were over-leveraged. Now, the selling pressure is looking to have leveled off, and the market appears poised for a rebound over the next few weeks.

All around, the market has been playing into the cycle of fear. The domestic market’s shortcomings are mirrored in that of currency markets, especially in the case of the Yen. However, it is nothing compared to what the internet news searches mentioned above claim. There is a certain inherent risk with currency, but as illustrated in Figure 1, this risk correlates with the risk involved with the S&P 500. The performance of the S&P 500 and the USD/JPY have had a strong correlation recently, which gives rise to the idea that a lot of the boom in the domestic equity markets is partly the result of the Yen carry trade. Figure 1 illustrates the correlation between the performance of the USD/JPY and the SPY (SPDR S&P 500 Tracking ETF).


There is some cause of fear for domestic Japanese investors who took their money offshore in the search for higher yields, investing in securities in countries such as New Zealand, Australia, Great Britain, and the United States. As with any investor who might have investments abroad, any negative currency movements would put strain on the ability to profit in those areas, because the idea is that one’s home currency should weaken against the currencies in the areas in which one’s investments are made. Everything is great when everything is sticking to the plan, but as investors have experienced over the past few weeks, all is not well in paradise, as there has been a massive exodus of money from foreign markets back into Japan.

This migration of money back to Japan is causing a substantial appreciation of the Yen, which exasperates the problem for Japanese investors who still have money abroad. The Japanese investors then exit positions, and bring the money back domestically. Figure 2 illustrates the performance of the NZD/JPY, which was the “ultimate” carry trade among the major currency pairs. Since July 21, 2007, the NZD/JPY pair has fallen almost 20% from its high, meaning the Japanese Yen has appreciated almost 20% against the New Zealand Dollar in less than a month. The performance of the pair is a prime example of how the carry trade can go wrong, because New Zealand was a country that Japanese investors flocked to in order to seek higher yields, and those investors were caught when the contagion hit.


Strength in the Yen has been a precursor to prior sell offs in the domestic equity markets, similar to what was experienced on February 27, 2007. The fear has always been, “when will the Bank of Japan raise interest rates that have been held at less than 1% for over a decade?” The question is pretty simple to answer; the odds that Yen interest rates will increase greatly is fairly small because Japan is a primarily export-driven economy.

The fact is that Japan exports $134.59 billion to the United States each year, yet only imports $62.89 billion back from the United States. The rest of Japan’s exporting takes places with other Asian countries, such as China (14.3%), South Korea (7.8%), Taiwan (6.8%), and Hong Kong (5.6%) (See Source), which, when looking at the Purchasing Power Parity, are all undervalued currencies, by comparison terms to the USD, because of the exporting nature of their economies. Japan, like China, would essentially be shooting its own domestic economy in the foot if it allowed its currency to appreciate any further or any faster than it already has. Goods such as automobiles and technology would not be as competitive against United States rivals in a situation with massive appreciation.

At this time, Japan would not risk another domestic meltdown after what they went through to recover from the Asian Crisis and other market shocks, which means that in the near term there will be no drastic changes to the current monetary policy. While these near zero interest rates may not be in place forever, the fear and overreaction gripping the market should now be taken with a grain of salt. The panic selling has finally dissipated and the over-leveraged have received their margin calls. The only question left to answer is, “Who will profit from the next upward carry trade wave?”

The intention of this article was not to incite an angry mob to short the Japanese Yen, but rather it is to inform the reader that there are many fear mongers in the market and their only goal is to get in at the very best price for themselves and their client. Wise investors have to look past all the media bologna and rely on their own analyses. Whether investing in the U.S. market, international markets, or currency markets, if it seems like the news can’t get any worse, it probably won’t, and it is probably time to pick up some of those discounted assets.

Here are some ways to play the rebound in the Yen Carry Trade:

  • Short CurrencyShares Japanese Yen Trust (NYSEARCA:FXY) - Bet that the Yen will depreciate versus the US Dollar.
  • Short iPath JPY/USD Exchange Rate ETN (NYSEARCA:JYN) - Bet that the Yen will depreciate versus the US Dollar.
  • Long PowerShares DB G10 Currency Harvest Fund (NYSEARCA:DBV) - Bet on going long the three highest yielding currencies and short the three lowest yielding currencies.
  • Combination of one or more of the CurrencyShares ETFs (Euro (NYSEARCA:FXE), British Pound (NYSEARCA:FXB), Australian Dollar (NYSEARCA:FXA), Canadian Dollar (NYSEARCA:FXC), Mexican Peso (NYSEARCA:FXM), Swedish Krona (NYSEARCA:FXS), Swiss Franc (NYSEARCA:FXF)), and a corresponding short CurrencyShares Japanese Yen Trust , giving investors flexibility to use currencies other than the US Dollar.
  • Long XXX/JPY pair in a retail Forex Account.
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