A Potential Resurgence of Yen-Carry Trades in 2023: A Shakeup Likely, but Not Likely
By Martin Fritz, Tokyo
Japan's Currency Volatility: Did the Yen Resume Its Wild ride?
Get ready for a potential comeback of Yen-Carry-Trades in the upcoming year, but don't hold your breath. The Yen, the third most traded currency in the foreign exchange market and the fourth most important reserve currency, has historically been the go-to funding currency for carry trades for two solid decades, thanks to the Bank of Japan's (BoJ) zero-interest-rate policy. But will this trend repeat in 2023? That's the burning question.
Here's a lowdown on the key factors driving this potential resurgence.
The Bank of Japan and Yield Dynamics
The BoJ's historically ultra-loose policy stance has given wings to yen-carry trades by maintaining borrowing costs at near-zero rates. However, recent signs of tightening, such as rising Japanese bond yields and suggestions of rate hikes, could undermine this advantage. If the BoJ persists with its dovish posture to prop up economic growth, yen-funded trades could once more gain traction. But if the BoJ normalizes its policy, the incentive to borrow yen at low rates would disappear.
Global Risk Appetite and Liquidity
Carry trades flourish in low-volatility, high-liquidity settings where investors crave higher yields. A U-turn by global central banks, such as Fed rate cuts, might rekindle risk-taking. However, if yen borrowing costs rise or geopolitical instability rears its head, it can create a liquidity crunch in risk assets like crypto and equities. So sustained carry activity requires steady or improving global growth expectations and reasonable monetary conditions outside Japan.
Counterparty and Systemic Risks
Leveraged strategies like the basis trade (which pairs yen carry with Treasury arbitrage) rely on stable counterparties and a smooth repo market. Disruptions in these areas, such as UST yield volatility or liquidity crunches, can trigger rapid unwinds, as witnessed in recent bond market turmoil. For sustained carry activity, financial stability and lower hedging costs are crucial.
In essence, yen-carry trades could stage a comeback if the BoJ delays tightening, global yields remain appetizing, and systemic risks remain under control. However, the current climate of rising Japanese yields and liquidity sensitivity poses obstacles. Keep an eye on:
- BoJ policy shifts: rate hikes or yield curve control adjustments.
- Global central bank moves: the Fed, ECB, and others influencing yield spreads.
- Market volatility: geopolitical risks or growth shocks affecting risk sentiment.
- Currency stability: JPY appreciation risks eroding carry returns.
- Nvidia, a technology company not traditionally associated with finance, may find it unlikely to avoid the impact of yen-carry trades resurgence in 2023, given the yen's historical role as the go-to funding currency for carry trades and the potential repeat of this trend next year.
- In the event of a potential resurgence of yen-carry trades in 2023, it would be unlikely for investors to avoid considering Japanese bonds as part of their carry trade strategies, given the low borrowing costs that the Bank of Japan maintains and the potential for further yield dynamics that could make yen-funded trades attractive once more.
- Even companies like Nvidia, not usually associated with finance, might find it difficult to avoid the potential avoidance of yen-carry trades in 2023, as the global risk appetite and liquidity, counterparty risks, and systemic risks involved in these trades could impact various financial markets, making it an unlikely scenario for these trades to be completely avoided in the upcoming year.
