Carry Trade Liquidation – How much will it unwind?

There is one question on the mind of most currency traders, and that is whether the carry trade liquidation is over.

Last Tuesday we saw the start of the global carry trade liquidation, with the Shanghai Stock Exchange closing approximately 9 percent below the open. This sell off was suspected to be started by speculation on whether the government will implement a capital gains tax of 20 percent in the upcoming fiscal year. The tax would have a negative effect on investors causing them to shy away from speculation with both personal and borrowed money. However, after investors determined that the tax was not going to be heavily enforced, the market began to show signs of a rebound. Nevertheless, the damage had been done, and the worried currency traders that were short the Yen became much more risk adverse, and resulted in traders closing their Short yen positions. This process has led to the strengthening of the Yen against almost every cross.

Over the course of the following week we have seen several major revisions in the exchange rates. The yen was able to realize approximately a 13 percent gain against the US dollar as the equity markets scoured. The market crash resulted in an unwinding of carry trades that resulted in the biggest weekly gain in the Japanese Yen against the US dollar in 14 months. In addition to the dollar, the yen increased 9 percent in value against the New Zealand Dollar, giving back almost 4 months of progress. The major factor that most people will be watching in these currency pairs is not whether they will retrace, but rather will they continue to decline before that retrancement occurs. The major event that traders will be keeping their eye on to help make this determination is unemployment numbers – Non-Farm Payroll – this Friday.