The Yen Carry Trade is Back

Includes: EWJ, FXY
by: Darrel Whitten

Just weeks after "the flight of the foreigners" and Japanese housewives being stopped out of highly leveraged forex trading positions, the yen is back to JPY117.54/US$ and JPY166.70/Euro, and options traders are the most bearish on the yen than they have been in three months.

What happened to all those scenarios claiming the yen was going to JPY100/US$ by the end of the year? The Australian, New Zealand and Canadian currencies are heading back toward multi-decade highs on renewed strength in commodities and demand for high-yielding currencies, and the yen has tumbled 11% against Australia's dollar and 12% versus New Zealand's in the past month.

All of this is occurring despite continued talk of further US rate cuts and of another hike in BOJ rates by March 2008 because this talk is having increasingly less credibility among traders, who are re-positioning for a bet that the U.S. economy will weather the worst housing slump in 16 years, or at least that a more accommodative Fed will continue to provide enough liquidity to support global stock markets, (which historically has been a good bet in a presidential election year).

As the MSCI index of Asia equities is setting new records, Asian currencies are strengthening, while Japanese equities are being supported by the renewed weakness in the yen.

Japan's muddling politicians are too busy shooting each other in the foot to pay much attention to the issues that concern foreign investors, like reducing a massive fiscal deficit and continued reforms. In addition, Japan's profile in the global economy continues to shrink and Japanese consumers are tightening their purse strings, meaning that the only path to growth for Japan at present is to leverage BRICs demand and continued strong demand for commodities.

This will continue weigh on the yen as the yen carry global liquidity ATM is revved up again. This time, however, there is much less froth in the move, as CME commitments of traders are basically flat, and the open interest in forex futures in Tokyo is down to half July peaks. This implies that the current yen weakness has legs.