The yen carry trade is a simple financial strategy that involves borrowing in Japanese yen, a currency with low-interest rates, to invest in higher-yielding currencies. This trade is profitable as long as the yen depreciates or remains stable relative to the invested currency. However, when the yen appreciates, losses can occur, especially if leverage has been used. Saddle-up for an in-depth analysis of the yen carry trade, its different forms, the estimated size of these trades, and the potential implications of their unwinding.
Understanding the Yen Carry Trade
The yen carry trade is a broad term that encompasses a variety of strategies and investors. The basic premise of a carry trade is borrowing in a low-interest-rate currency, such as the yen, and investing in higher-yielding currencies or assets. This trade has been popular among a wide range of investors, from foreign investors to individual Japanese investors, colloquially known as “Mrs. Watanabe,” who used short-term leverage to profit from interest rate differentials between Japan and other countries. Common target currencies include the U.S. dollar, but also emerging market currencies such as the Brazilian real, Mexican peso, and Turkish lira.
In addition to speculative short-term trades, long-term institutional investments also constitute a significant portion of the yen carry trade. Japanese pension funds, insurance companies, and institutions like the Norinchukin Bank have accumulated substantial foreign assets, often on an unhedged basis. For instance, the Government Pension Investment Fund (GPIF), which manages a portfolio worth $1.7 trillion, has half of its investments in overseas assets, frequently unhedged against currency fluctuations.
One of the key examples of carry trades that do not involve leverage is the widespread use of Swiss-franc-based mortgages in central and eastern Europe before the 2008 financial crisis. These mortgages were another form of carry trade where borrowers in these regions took advantage of the low interest rates in Switzerland to fund domestic real estate purchases. This example illustrates that carry trades can occur without explicit leverage and can involve domestic investments funded by foreign currency borrowing.
The Role of Currency Mismatch
Subscribe!