By Les Commons As if forgetting all the lessons of recent history, it appears many hedge fund...
By Les Commons
As if forgetting all the lessons of recent history, it appears many hedge fund managers are again piling back into the 'yen carry trade', the same trade rumoured to lie behind the demise of hedge fund behemoth Long Term Capital Management in 1998.
With short-term interest rates in Japan at close to zero, banks and hedge funds are again financing positions in higher yielding currencies by borrowing in yen. This 'yen carry trade', as it is called, helps keep the yen cheap.
The strategy assumes there is no risk the yen will appreciate, thereby causing growing yen liabilities. Speculators think the currency movements could only be in one direction and that their investments in other currencies would show a positive income return as well as an appreciation against the yen.
The original 'yen carry trades' came unstuck in the financial crisis of 1998. The yen/dollar rate saw the biggest one-day swing since the collapse of the Bretton Woods exchange rate regime in the early 1970s. Over two days on 7 and 8 October 1998, the US currency plunged by more than 13% against the yen to ´117.
With Japanese interest rates near zero and the currency again seemingly on a one-way journey to oblivion, all the conditions for the carry trade are back in position. It is suggested that funds have again borrowed yen at low rates, sold the yen proceeds for euros, but mainly dollars, and invested the proceeds into European and US government bonds.
In recent months, this has led to good capital returns on bonds trading at two to three year highs, good rates of yield return on 0% borrowings and, due to the slumping yen, additional profits on currency returns.
However, this trade is starting to worry many investment analysts. For a start, there are many who feel that global bond markets are starting to look expensive.
From a chartist's point of view, the benchmark 30-year US Treasury bond is certainly looking overbought. This could see a downturn in bond prices, leading to lower capital gains, and even losses on funds' bond portfolios.
Also, many are getting particularly worried about the value of the dollar, which has continued to push higher against all major currencies, especially the yen, despite the continued trade gap and worries over US growth.
The 'yen carry trade' is unlikely to be a major worry for markets or even for central bankers until rates in the US and Japan rise or the yen appreciates substantially.
Therefore, the trade will remain in play for a while to come, despite fears of falls in global bonds. It still offers a cheap route into financing of trades. If the suggestions of some currency analysts that see the yen falling to 135 against the dollar are right, there is still plenty of room for currency appreciation to cover falls in bonds.
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