Less yen for carry this time

April 5, 2013

The Bank of Japan unleashed its full firepower this week, pushing the yen to 3-1/2 year lows of 97 per dollar.  Year-to-date, the currency is down 11 percent to the dollar. But those hoping for a return to the carry trade boom of yesteryear may wait in vain.

The weaker yen of pre-crisis years was a strong plus for emerging assets, especially for high-yield currencies. Japanese savers chased rising overseas currencies by buying high-yield foreign bonds and as foreigners sold used cheap yen funding for interest rate carry trades. But there’s been little sign of a repeat of that behaviour as the yen has fallen sharply again recently .

Most emerging currencies are flatlining this year and some such as the Korean won and Taiwan dollar are deep in the red. The first reason is dollar strength of course, but there are other issues. Take equities — clearly some cash at the margins is rotating out to Japan, where equity mutual funds have received $14 billion over the past 16 weeks.  While the Nikkei is up 21 percent, Asian indices are broadly flat. In South Korea whose auto firms such as Hyundai and Kia compete with Japan’s Toyota and Honda, shares are bleeding foreign cash. The exodus has helped push the won down 5 percent to the dollar in 2013.

Second, the much-vaunted outflows from Japan have not yet lived up to expectations.  JPMorgan tracks Japanese investment trusts with $67 billion in assets but says only $2.3 billion have flowed to emerging bonds this year, all of it in January and February.

But most crucially,  emerging markets and their currencies are just not as attractive as they were back in 2004-2007 — the heyday of the carry trade.

Back then, economic growth in emerging markets was booming,  currencies were strengthening and interest rates were high. Now the gap between developed and emerging markets GDP growth has shrunk to a decade-low of just three percentage points. Emerging corporates’ profit growth has is running at flat. And policymakers are far less inclined to tolerate hot money flows that will push up their currencies. That’s especially so in Asia where countries often compete with Japan on exports.

Bhanu Baweja, a UBS strategist, says investors seeking “a playback of the mid-2000s” are being over-optimistic. He notes for instance that emerging currencies offered carry of 8-10 percent back in 2008, compared to around 4 percent now. Therefore the correlation between yen and emerging currencies will  turn out less negative than many expect and could even turn positive if exports fail to pick up, he warned clients in a recent note. (see graphic)


Aside from 2004-2007, Baweja notes two other recent periods of yen weakness  — the first, around the Asian crisis of 1997-98 when emerging currencies weakened along with yen; second around 2000-2001, a time of weak global growth and crises in Argentina and Turkey.  That time, emerging currencies stayed broadly flat on a trade-weighted basis.  So the 2004-2007 period may just have been an exceptional time when the stars were aligned for EM carry trades, he says.

Sebastian Barbe at Credit Agricole in Paris broadly agrees with this analysis. But he does expect the carry trade will pick up in time — selectively. It is difficult for the Korean won and Taiwan dollar to appreciate when the Nikkei is booming and the yen falling, Barbe says, but currencies in Latin America may gain, especially as some countries such as Brazil will start raising interest rates this year. Even in Asia, some currencies such as Thai baht can be seen as appreciation bets.

Emerging markets should take heart however. If Japan’s economy picks up after 16 years of deflation, all will benefit.  And a weak yen is not bad news for everyone — many Asian countries such as Thailand, Malaysia and Indonesia import Japanese car and electronics components to  assemble and sell locally.

Societe Generale analyst Wee-Khoon Chong says:

The yen move is creating uncertainty on exports in the region so I would say the impact so far is negative… but longer term no one will complain if Japan is out of recession and sees stronger growth.


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