The carry-trade rewind

By Felix Salmon
April 7, 2011
Remember the sharp and painful rally in the yen following the Japanese earthquake in March? I described the 4% move as a "monster", adding that "Japan, after being hit first by an earthquake, then by a tsunami, and then by nuclear disaster, is now going to have to suffer the effects of a volatile and overvalued currency as well".

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

Remember the sharp and painful rally in the yen following the Japanese earthquake in March? I described the 4% move as a “monster,” adding that “Japan, after being hit first by an earthquake, then by a tsunami, and then by nuclear disaster, is now going to have to suffer the effects of a volatile and overvalued currency as well.”

Well, I got the “volatile” bit right:

chartcurrency20110407130244.jpg

In the wake of the post-earthquake high of 76.25 yen to the dollar, there’s been a spectacular — and wholly welcome — plunge; you can now get 85.5 yen for your buck. That’s a fall of about 12% over the course of three weeks — a truly enormous move for one of the world’s two biggest currency pairs.

Just as the post-earthquake rally in the yen was caused by an unwinding of carry trades, it seems as though the reverse move is a function of the global carry trade being put back on. But these flows are extremely volatile and unpredictable, and it’s entirely possible that the yen is going to bounce back from its current lows. (Which, to put things in perspective, aren’t that low: for those of us used to yen/dollar being in the 120 range, the Japanese currency is still extremely strong.)

Japanese exporters would naturally prefer both a weaker yen and less currency volatility than they have right now. Might they miss the carry traders if they go away, scared by the prospect of losing years of gains in a matter of minutes? The carry traders, after all, are Japanese exporters’ friends — they’re the people shorting the yen and driving it lower. But no trade lasts forever, and any yen weakness caused by traders putting on a trade will surely be counterbalanced eventually by the same traders unwinding it. Much better that the yen drift slowly back towards 100 of its own accord, without any artificial push from the FX markets.

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
3 comments so far

Why 100 (or 120)? 50 years ago it was 360.

In principle, a persistently low-interest rate currency is supposed to drift higher. In practice, uncovered interest parity doesn’t hold over short periods of time; my impression is that nominal rates tend to move in the right direction in jumps, so that carry trades work until the carry traders get hit. I don’t have data on this, though; I’d be wary of asserting some sort of mean reversion, though, as though the yen/dollar exchange rate ten or twenty years ago is a good prediction of where it will be in the future.

Posted by dWj | Report as abusive

What on earth does “Much better that the yen drift slowly back towards 100 of its own accord, without any artificial push from the FX markets” mean?

Pray tell how exactly a market price would “drift slowly…of its own accord”? If the market isn’t doing the pushing, who is? Who do you think trades in the interbank FX market? It’s not just hedge funds running a carry trade, but it’s not clear to me why their positions should be somehow less legitimate than those of banks, corporations, and governments.

Finally, how on earth can you write about the yen’s recent depreciation without mentioning that it’s been accompanied (and perhaps caused) by a sustained, coordinated G7 intervention?

You assert that the initial post-earthquake appreciation and the subsequent depreciation are because of the global carry trade in the absence of any evidence whatsoever. You could be right, but I’d love to know how you’re so convinced about something so fundamentally unmeasurable.

Posted by loudnotes | Report as abusive

“It’s not just hedge funds running a carry trade, but it’s not clear to me why their positions should be somehow less legitimate than those of banks, corporations, and governments.”

Word. It’s none of our business to make moral distinctions between market players.

Posted by SGKingsley | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/