Concerns about unwinding yen carry trades are resurfacing. The likelihood of a Bank of Japan (BOJ) rate hike this month has increased, while U.S. rate cuts are seen as a given. Still, analysts say a gradual yen appreciation lowers the chances of a shock on the scale of last year.
A carry trade is a strategy of borrowing a low-interest currency such as the yen and investing in overseas asset with higher rates. Weakness and low rates in the funding currency are prerequisites to gaining both interest differentials and FX gains. Unwinding of yen carry trades means investors sell overseas asset and repatriate funds as the outlook for revenue shrinks due to a Bank of Japan policy rate hike.
According to Investing.com on the 6th, the Japanese 2-year government bond yield, which is sensitive to monetary policy, rose 2.5 basis points from the previous day on the 5th to 1.047%. 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 markets have begun fully pricing in a possible Bank of Japan rate hike.
On the 1st, Bank of Japan Governor Kazuo Ueda said, "We will make an appropriate judgment on whether to raise (rates)," adding that policy will be calibrated "neither too late nor too fast." Markets took the remarks as a signal of a rate hike at the monetary policy meeting on the 18th–19th.
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%. Government bond yields in major economies including the United States and Germany rose in unison (bond prices fell), and the three major New York stock indexes also declined together. As risk aversion increased, Bitcoin fell more than 7%.
Markets are again raising concerns about yen carry unwinds. Observers say the current situation resembles "Black Monday" in Aug. last year. On Aug. 5 last year, the KOSPI and KOSDAQ indexes plunged more than 8% and 11%, respectively, and the exchange pointed to yen carry unwinds as the cause of the plunge. At the time, the Bank of Japan delivered a July rate hike that markets had not expected, while U.S. rates had entered a cutting cycle. The rate environment was similar to now.
However, the consensus is that a repeat of last year's shock is unlikely. That is because the yen strength 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 appreciation will be limited. In fact, the dollar-yen rate is around 154, 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 short-yen positions close out at once, sending the yen sharply higher and triggering a chain of unwinds in the process. But current speculative short-yen positioning is not large, making a sharp correction like last year less likely, according to assessments.
Choi Yechan, a researcher at Sangsangin Investment & Securities, said, "There are not many short-yen positions that would trigger a chain unwind, so it is not yet time to worry about a yen carry unwind," adding, "Given that nonresident outstanding loan balance in yen declined gradually through the second quarter this year, some yen borrowing appears to have been returned. The likelihood of further unwinds is low."