Yen's strength raises fears over global carry trades

HONG KONG - THE yen yesterday headed for its biggest weekly gain against the US dollar in 14 months, raising fears about the unravelling of the global carry trade.

The continued strengthening of the yen comes in the wake of a widespread downturn and volatility across the global equity market - which initially started on Tuesday when the mainland Chinese stock market fell by nearly 9 per cent.

The selling of equities appears to have been triggered by a strengthening of the yen. A stronger yen puts pressure on global carry trades, because it makes it less attractive to sell the low-yielding Japanese currency to buy higher-yielding assets in other currencies.

Carry trades are when investors borrow in a low-yielding currency to invest in higher-yielding assets.

Some analysts have said that investors who faced losses in equities were closing profitable carry trade positions.

As the yen strengthened, high-yielding currencies, including the New Zealand dollar and the South African rand, tumbled yesterday.

The yen has already gained almost 3 per cent this week, the biggest increase since late 2005, and was at 117.66 against the US dollar in late trading in Tokyo yesterday.

On Thursday, the yen reached 116.97 against the US dollar, the highest since Dec 13, after rebounding from a four-year low of 122.19 at the end of January.

Mr Eisuke Sakakibara, Japan's former vice-finance minister, said currency traders had long enjoyed an unusual period of stability, but that conditions 'could change this year'.

However, he predicted that this week's movement was not the start of carry trade unwinding, saying he expected the yen to trade within a 115 yen to 120 yen range against the US dollar for the rest of the year.

'The carry trade is going to continue for some time and the weak yen tendency is not going to be reversed so quickly.'

He said the Bank of Japan, which last week raised rates a notch to 0.5 per cent, could move again, faster than markets expected, and that a rate rise as early as May was possible.

However, he added that, as long as interest rate differentials with the rest of the world remained so high, a rapid unwinding of the trade was unlikely.

Economy Minister Hiroko Ota said the strengthening of the yen in the past few days would not have a substantial effect on the economy.

FINANCIAL TIMES