Yen Rises Above 110 as Carry Trades Unwind

Oh, we are in for a wild ride. The long-anticipated and much delayed unwind of the carry trade appears to be underway, due to credit market fears. For those new to the concept, the carry trade involves borrowing where interest rates are low (typically in a cheap currency, like the yen, where interest rates are a mere 0.5%) and the investing in assets that offer higher yield, in this case in countries like New Zealand. Australia, and the US, which offer higher rates. The trader earns a spread on his cost of funding versus his investment yield. To execute this strategy, he sells the borrowed yen and buys the foreign currency. The yen selling kept the value of the yen artificially low.

The risk in this pretty picture is that the price of the currency in which he is borrowing appreciates, making what he owes in yen terms much more costly and wiping out his spread profits. Thus traders buy yen in haste so they can cover their yen borrowing, which leads to the rapid currency appreciation we’ve seen in the last few days.

From Bloomberg:

The yen strengthened beyond 110 against the dollar for the first time in 1 1/2-years as a slump in Asian stocks prompted investors to cut holdings of higher- yielding assets bought with money borrowed in Japan.

The currency climbed to the highest in almost two months against New Zealand’s dollar, a favorite target of the so-called carry trade, on speculation HSBC Holdings Plc will this week announce losses stemming from bad U.S. home loans. The yen gained almost 1 percent versus the euro as Asian equity markets dropped the most since Aug. 17.

“The big beneficiary at the moment is the yen,” said Sue Trinh, a senior currency strategist in Sydney at RBC Capital Markets, the second-most accurate forecaster of exchange rates in the second quarter in Bloomberg surveys. “Risk aversion has dominated and we’ve seen the carry trade unwind.”

The yen traded at 110.00 per dollar at 12:42 p.m. in Tokyo and touched 109.96, the highest since May 2006, from 110.69 late in New York Nov. 9. It was at 161.95 per euro from 162.48 late last week. Trading volumes in Asia may be less than normal as today is a trading holiday in the U.S….

The yen gained against all of the 16 most-actively traded currencies after the Daily Telegraph reported HSBC, Europe’s largest bank by market value, is set to announce $1 billion of bad debts stemming from its U.S. mortgage business this week….

The yen has risen 7.7 percent against the dollar so far this year and cut its losses versus the euro to 2.9 percent as concerns the housing slump in the U.S. is deepening prompts investors to repay loans in Japan. The world’s biggest banks have written down at least $40 billion as prices of mortgage- related assets plummeted.

Credit-market turmoil prompted the Reserve Bank of Australia to buy the nation’s currency in August for the first time since 2001 to help steady foreign exchange markets, the central bank said in its quarterly monetary statement today….

Gains in the yen may be limited on speculation Japanese importers will take advantage of its gains by selling it for other currencies to buy goods overseas.

“We haven’t seen the yen this strong in a while, so Japanese importers may want to sell into this rally,” said Masahiro Sato, joint general manager of the treasury division at Mizuho Trust & Banking Co. in Tokyo, a unit of Japan’s second- largest publicly traded lender. “There seems to be lots of buy orders for euro, and other yen crosses.”

The yen may fall to 111 against the dollar and 162.50 per euro today, he said.

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