U.S.-Japan yen intervention, Bank of Japan: carry trade

Japan’s historic effort to prop up the yen may have had an unintended consequence: giving some investors a better opportunity to double down on carry trade.

Japanese investors net bought more than 5 trillion yen of foreign equities and long-term bonds over the two weeks ended Aug. 15, compared with net selling of over 300 billion yen in the prior two weeks, according to Ministry of Finance data.

The purchases suggest investors took advantage of the yen’s sharp rally following last month’s joint U.S.-Japan currency intervention to snap up overseas assets at more favorable exchange rates, said market watchers.

“Intervention has ‘turbo charged’ the carry trade for fundamental & long term investors,” according Jesper Koll, expert director at Monex Group. “As long as the cost of money in Japan is lower than the return overseas, carry trades will re-assert,” Koll said.

While authorities succeeded in jolting the yen higher, they did little to change the incentive for investors to borrow or raise funds cheaply in Japan and put the money into higher-yielding assets abroad.

The yen strengthened from around 164 per dollar before the intervention to roughly 155, but quickly surrendered a large chunk of those gains. It has since weakened back toward 159 against the greenback.

That has reinforced expectations that the yen will remain under pressure unless the Bank of Japan raises rates enough to materially narrow the bond yield gap with the U.S. The U.S.-Japan 10-year yield spread stood at roughly 1.8 percentage point as of Thursday.

The short-lived yen gains signal that investors are treating bouts of yen strength as opportunities to rebuild carry trade positions rather than abandon them.

That dynamic is particularly visible among Japanese institutional investors. Long-term investors such as pension funds and asset managers continued selling yen, according to Masahiko Loo, fixed income strategist at State Street Investment Management.

“The intervention only addressed a ‘symptom’, but [is] not curing the ‘disease,'” said Francis Tan, Asia chief strategist at Indosuez Wealth Management, referring to the structural forces including Japan’s low borrowing costs and wide interest-rate differentials with other major economies.

Koll also said that Japanese retail and institutional investors have used the stronger yen to establish new positions in non-yen assets, particularly higher-yielding U.S. bills and bonds.

“The market is far less one-sided than before the intervention, but the incentives to fund in yen remain attractive while U.S.-Japan rate differentials stay wide,” Loo said.

Other flow data point more directly to carry positions being maintained. Long-term investors are continuing to sell low-yielding yen against higher-yielding G10 currencies, consistent with investors using the Japanese currency to fund positions elsewhere, said to Masahiko Loo, fixed income strategist at State Street Global Advisors.

Alpha Binwani Capital’s founder Ashwin Binwani said institutional investors remained positioned in carry trades against a basket of G10 currencies, led by the Australian dollar.

There are also signs that some currency traders are rebuilding bearish bets on the yen, as the impact of the intervention has faded.

Binwani exited long dollar-yen positions after the U.S.-backed intervention, before re-establishing them just above 157, expecting the yen to weaken going forward. “Upon news of the U.S. intervention, we took profit and once again re-established dollar yen long positions just slightly above 157,” he said.

Binwani said each intervention-driven rally could potentially offer investors a better entry point to sell the currency. While distinct from borrowing yen to invest directly in higher-yielding assets, the trade is underpinned by the same fundamental force: Japan’s relatively low interest rates that keep its currency under pressure.

Overall, speculative positions against the yen, however, have declined. CFTC data show leveraged funds slashed net short yen positions from almost 138,000 contracts at the end of June to 59,526 as of Aug. 11, as authorities demonstrated their willingness to intervene.