Reboot of yen carry trade looks tempting but risky
By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Is it time to reboot the yen carry trade? The Japanese currency is at historic highs, with most logic pointing toward depreciation. That makes the trade that involves borrowing cheaply in yen and investing elsewhere look interesting — but volatility makes it perilous.
Ultra-low interest rates in Japan led hedge funds and small investors alike to borrow heavily there and invest in higher-yielding securities elsewhere in the boom years before the 2008 crisis. Today, using this so-called carry trade, in theory an investor can borrow for next-to-nothing in yen and invest the money fairly safely for much higher returns, for example in two-year Australian government bonds yielding around 4.75 percent.
The game is particularly enticing when it looks as if the yen will fall in value. That way an investor collects not only a yield differential but also a profit when an investment is sold for Australian dollars, using the same example, which by then buy more yen than originally borrowed.
The Japanese currency certainly looks overvalued. It spiked to a level near 76 to the dollar on Thursday, the strongest it has been since World War Two, before weakening a bit to nearer 79. Investors fear that companies and the government will sell foreign assets and buy yen to pay for damage stemming from last Friday’s massive earthquake and tsunami.
That concern looks overdone in reality, suggesting the yen could weaken again. The Japanese government also suggested the huge swing was speculative, perhaps paving the way for intervention to depreciate the currency. And heavy government spending on reconstruction may reduce the risk of deflation, while the central bank is unlikely to raise interest rates, also potentially weakening the yen.
The big danger, though, is that a currency move in the wrong direction swamps the extra yield available. Anyone setting up an obvious carry trade at the beginning of this year would by now be out of pocket thanks to the yen’s strength, especially after Thursday’s huge 4 percent surge in the currency. And the yen could strengthen further for specious or sound reasons, while volatility has been extreme since the earthquake hit. That risk is likely to keep most investors on the sidelines. Any takers for the bet shouldn’t reckon on sleeping well.