With perpetually low interest rates, carry trade plays a big part in Japan’s exchange rate. Carry trading is a strategy in which an investor sells a certain currency with a relatively low interest rate, typically the JPY and currently also the USD, and uses the funds to purchase another higher yielding currency. The higher the interest rates in a country the higher the yield of its assets. A trader using this strategy attempts to capture the difference between the rates.
After the fall of Lehman Brothers and the onset of the financial crisis, carry trades have practically disappeared as risk aversion ruled the markets and traders turned to the safe haven status of the Japanese and American currencies. However, with an increasing influx of optimistic economic data in the past few months carry trades have started to come back into the picture with traders betting on an eminent economic recovery which prompted them to search for higher yielding assets, pushing them to purchase riskier currencies, financed with the Yen.
The recent return to risk aversion following the worse than expected employment data from the U.S has pushed investors back to the safety of the Yen as global stock markets fell and traders fled from carry trade activity. This played a role in Yen’s recent rally as unwinding of carry trades means that traders now need to liquidate their investments of the higher yielding assets and purchase Yen in order to repay their Yen denominated loans.
Currently market conditions continue to be mixed and directionless, with the weak employment data bursting the quick global recovery bubble. In the current market state it is unlikely carry trades will return as long as the economic fundamentals remain shaky.
