Japanese yen to US dollar carry trade still popular on currency market

The Japanese yen to US dollar carry trade, which involves hungry investors borrowing in Japanese yen to bet on the higher yielding US dollar, is still popular on the global currency market.

In the $4 trillion a day global foreign exchange market, carry trades in which investors play the yield differential of one asset against another are widespread amongst the major currencies such as the dollar, euro and yen.

Recent stronger US economic data is expected to drive up US Treasury yields in anticipation of a pickup in inflation further down the road, burnishing the appeal of borrowing cheaply in Japanese yen to buy higher yielding US bonds, several analysts said.

“The US economy is still well supported where you have an accommodative monetary policy, as well as fiscal policy, whereas Japanese interest rates are anchored by slow Japanese growth,” said Mark McCormick, currency strategist at Brown Brothers Harriman in New York.

Many investors were disappointed after the US Labor Department released data showing payrolls increased by 103,000 last month, well below the consensus estimate of 150,000 that followed Wednesday’s private payrolls data.

But the most closely linked correlation explaining US dollar to yen movement is Treasury yields over Japanese yields, and that dynamic remains firmly in place, analysts said. As Treasury yields have risen since early November, the yield spread of 2 year Treasury notes over equivalent Japanese government bonds has doubled to about 40 basis points.

Even with the level of US yields expected to fall slightly over the next three months, the dollar should rise to Y86 from about Y83 now, said Credit Suisse FX strategy analysts.

That projection is partly based on the bank’s US rate strategy team’s forecast for two-year Treasurys to fall to a 0.500% yield over the three-month period.

While the carry trade is seemingly an easy way to make a quick return, one of this strategy’s inherent risks are wild swings in currency exchange rates, analysts said.

If the US dollar were to suddenly fall sharply against the Japanese yen, investors would lose large amounts of money because of leverage typically employed in these trades. Hedging to avoid large losses can be expensive, which is one reason to forgo the trade.

But volatility between the interest rate differentials backing the US dollar and the yen should decrease if the trend of a recovering US economy becomes more established, analysts said.

“All else being equal, Friday’s non-farm payrolls day was positive for the carry trade. To the extent that the non-farm payrolls number is low but not too low, interest rate volatility, which remains historically elevated, should decline from here.” said David Woo at Bank of America Merrill Lynch.

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