Institutions: Yen is set to strengthen, carry trades face risk
Source: Global Market Briefing
According to Stephen Jen of Eurizon SLJ Capital, the yen is expected to strengthen against the dollar, reversing months of weakness and potentially disrupting a popular trading strategy that relies on a weak yen.
Jen, the company's CEO, together with economist and portfolio manager Joana Freire, wrote in a report on Tuesday that the yen has long been the preferred funding currency for investors engaging in so-called carry trades.
While this strategy has succeeded this year thanks to a weak yen and Japan's relatively low interest rates, they warned that as conditions change, particularly when positions become one-sided, there is a risk of a sharp reversal.
They wrote that expectations of faster economic growth in Japan, prospects for rising benchmark interest rates, and pro-business government policies all set the stage for capital to flow back into the Asian nation and for the currency to strengthen.
"Carry trades appear very stable—until they don't." They also cited the example of October 1998, when the yen suddenly surged against the dollar and hedge funds scrambled to unwind positions.
Recent interventions by Japanese authorities to support the yen have already reduced holdings of the currency, according to Eurizon economists. They believe that authorities and the U.S. Treasury are likely to coordinate joint interventions. Citigroup has recommended selling the dollar against the yen before next month's Bank of Japan meeting, while Bank of America recently listed three major catalysts that could turn it bullish on the yen.
The Eurizon team stated that a stronger yen against the dollar doesn't require a crisis, and "the experience of 1998 is instructive." However, they also pointed out that the current situation is different, such as Japan’s economy and financial system being more robust now than back then.
As of Tuesday afternoon in New York, the yen traded at 159.33 to the dollar, weaker than its level around 156 before the United States struck Iran in February, an event that roiled energy markets.
"The oil crisis may have delayed a pullback of the dollar/yen pair," they wrote, but under the new Fed chair Kevin Warsh, "rate cuts could resume one day, putting the dollar/yen in the spotlight again, and Japan's economy is clearly capable of absorbing a stronger yen."
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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