Japan’s recent currency intervention, aimed at strengthening the yen, has paradoxically ‘turbo charged’ the carry trade. Investors are leveraging Japan’s low borrowing costs to invest in higher-yielding foreign assets, with significant net buying of overseas equities and bonds observed following the intervention.
Despite a temporary yen rally, the underlying interest rate differentials remain, encouraging carry trades and signaling continued pressure on the yen unless the Bank of Japan significantly narrows the yield gap with the U.S.
Japan's recent, historic intervention to bolster the yen may have inadvertently created a prime opportunity for investors to ramp up their carry trades, according to market analysts. Despite the yen's brief surge following joint U.S.-Japan currency action, the underlying incentives for borrowing cheaply in Japan and investing abroad remain firmly in place.
Data from Japan's Ministry of Finance reveals a significant shift in investor behavior. In the two weeks leading up to mid-August, Japanese investors snapped up over 5 trillion yen in foreign equities and long-term bonds, a stark contrast to the more than 300 billion yen they sold in the preceding two weeks.
Jesper Koll, expert director at Monex Group, described the intervention's effect as "turbo charging" the carry trade. "As long as the cost of money in Japan is lower than the return overseas, carry trades will re-assert," Koll stated, emphasizing that the intervention did not address the fundamental attractiveness of Japan's low borrowing costs.
Yen performance year-to-date
While the intervention temporarily strengthened the yen from around 164 to 155 against the dollar, these gains proved fleeting, with the currency quickly retreating to near 159. This rapid reversal underscores the persistent pressure on the Bank of Japan to narrow the yield differential with the U.S., which stood at approximately 1.8 percentage points for 10-year yields as of Thursday.
Market watchers interpret these short-lived yen rallies not as a signal of abandonment, but rather as tactical opportunities for investors to re-establish or expand their carry trade positions. Masahiko Loo, fixed income strategist at State Street Investment Management, noted that Japanese institutional investors, such as pension funds and asset managers, continue to offload yen in favor of higher-yielding foreign assets.
Francis Tan, Asia chief strategist at Indosuez Wealth Management, remarked that the intervention addressed only a "symptom" rather than the underlying "disease" – the structural factors like Japan's low interest rates and wide global yield differentials.
Koll further elaborated that both retail and institutional investors have utilized the stronger yen to initiate new positions in non-yen assets, particularly U.S. bills and bonds offering higher yields. Loo added that despite the market being less one-sided post-intervention, the attractiveness of yen funding, coupled with wide U.S.-Japan rate differentials, persists.
Data on currency flows indicates a continued trend of investors selling low-yielding yen to fund positions in higher-yielding G10 currencies, with the Australian dollar being a prominent example. Ashwin Binwani, founder of Alpha Binwani Capital, observed that institutional investors remain positioned in these carry trades.
Some currency traders are also reportedly rebuilding bearish bets on the yen as the intervention's impact wanes. Binwani himself exited long dollar-yen positions following the U.S. intervention, only to re-establish them above 157, anticipating further yen depreciation. He suggested that intervention-driven rallies might serve as better entry points for those looking to sell the yen, a strategy fundamentally driven by Japan's persistently low interest rates.
While speculative positions against the yen have decreased overall, with leveraged funds significantly reducing net short positions according to CFTC data, the underlying incentives for carry trades remain robust, suggesting continued pressure on the yen.
