Yen Crosses Start Their Fall

Yen carry trades have dominated the forex market for the past couple of months.  With international equities markets booming and high yields to be found in other countries, traders have been borrowing the yen on the cheap to finance their investments.  That has brought the yen to multi-decade lows against all the highly traded currencies.  But yen crosses look to be in line for a corrective decline.

The engine for carry trade demand has been the search for higher yields elsewhere in the world.  And the relative ease with which those yields could be found encouraged currency traders.  However, global equities are falling and credit spreads are beginning to widen.  Forex investors are seeing these developments and reacting with worry.  They are paring risk and liquidating their carry trade positioning.  As evidence of this situation, USD/JPY touched 119.12 per dollar in New York trading this morning, its lowest level since May 1.  EUR/JPY has regressed as well, falling to as low as 163.88 per euro.

The other factor contributing to the carry trade unwind is the possibility that shorting the yen will cease to be a one way bet.  There is growing speculation that Japan may intervene in the fx market to prop up its currency, and it certainly has the foreign reserves to do some damage.  Bank of Japan board member Tadao Noda spoke yesterday about the risks associated with a weak currency.  Hiroki Tsuda of the Finance Ministry warned the market that currencies should reflect economic fundamental and that the government would be watching the forex market for irregularities. The impact of both of these statements is that, if believed, they could serve to lower capital outflows from Japan.

There are fundamental signs that the Japanese economy is ready for an appreciation of its currency.  Consumer spending seems to be recovering, with CSPI printing at a year-over-year growth of 0.6%, a 10-year high.  Household spending has been in positive territory since the beginning of this year, suggesting that price action is likely to drive yen crosses even lower.  Forex professionals have been predicting movement in the yen to 115 for months now, and there have been reports in Bloomberg about Japanese housewives keeping the carry trade afloat.  It has been very tempting to be short the Japanese yen in recent times; you can earn the carried interest without threat of a swing back in favor of the yen.  And while you may have made a good deal of money this way, it might be time to look elsewhere for your investments.  One of the worst moves a forex trader can make is to fall in love with his own trades, and the time is now to unwind the carry trade and find some other vehicle for growth.