Concerns about unwinding yen carry trades are resurfacing. The likelihood of a Bank of Japan (BOJ) rate hike this month has grown, while U.S. rate cuts are seen as a done deal. Still, analysts say a stronger yen is likely to unfold gradually, making a repeat of last year's shock less likely.
A carry trade is a strategy of borrowing a low-interest currency, such as Japan's, to invest in overseas asset with higher rates. The weakness of the funding currency and low rates are prerequisites to earn both interest differentials and FX gains. Unwinding yen carry trades refers to investors selling overseas asset and repatriating funds as revenue prospects shrink due to a Bank of Japan policy rate hike.
According to Investing.com on the 6th, the yield on Japan's 2-year Government Bonds, which are sensitive to monetary policy, was 1.047% on the 5th, up 2.5 bp from the previous day. It is the first time in about 17 years since 2008 that the 2-year yield has topped 1%. Bond prices and yields move in opposite directions, suggesting the likelihood of a BOJ policy rate hike is being fully priced in.
Earlier, BOJ Governor Kazuo Ueda said on the 1st of this month, "We want to make an appropriate judgment on whether to raise (rates)," adding, "We will calibrate the degree of easing appropriately, neither too late nor too early." Markets view the remarks as signaling a rate hike at the Monetary Policy Meeting on Aug. 18–19.
Markets reacted immediately after Ueda's comments. Japan's 2-year government bond yield surged into the 1% range, and the 10-year topped 1.7%. Benchmark government bond yields in major countries including the United States and Germany rose in unison (bond prices fell), and the three major New York stock indexes also fell together. As risk aversion grew, bitcoin plunged about 7%.
Markets are again raising concerns about a yen carry unwind. That is because the current situation is being likened to "Black Monday" last Aug. On Aug. 5 last year, the KOSPI and KOSDAQ indexes plunged more than 8% and 11%, respectively, and the exchange pinpointed a carry unwind as the cause of the plunge. At the time, the BOJ delivered an unexpected July rate hike, while the United States had entered a rate-cut cycle. The rate environment was similar to today.
Still, the prevailing view is that a replay of last year's shock is unlikely. The stronger yen that would act as a "trigger" for a carry unwind is not pronounced. With the Takaichi cabinet maintaining large-scale stimulus and a liquidity-supply stance, analysts say yen strength will be limited. In fact, the dollar–yen rate is around 154 yen, still in a relatively weak-yen phase.
Another difference is that speculative positions with a high likelihood of being unwound have already been largely reduced. Typically, a yen carry unwind sees accumulated speculative yen short positions covered all at once, sending the yen surging and triggering a cascade of unwinds. But the current size of speculative yen shorts is not large, leading to the assessment that the chance of a sharp correction like last year's is limited.
Choi Ye-chan of Sangsangin Investment & Securities said, "There are not many yen short positions that could spark a chain of unwinds, so it is not yet time to worry about a carry unwind," adding, "Considering that nonresidents' outstanding loan balance in yen declined gradually through the second quarter of this year, some of the yen borrowing appears to have been reversed. The potential for additional unwinds is low."