The carry-trade rewind
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:
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.