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Can Conditions Be Any Better For The Yen Carry Trade?

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Carry trade currencies

Published: June 6 2007 14:47 | Last updated: June 6 2007 14:47

Can conditions be any better for the yen carry trade? It seems not, if recent moves in the currency markets are anything to go by. The popular destination currencies for those borrowing yen at low interest rates are flying. The Australian dollar is now at an 18-year high against the US dollar. New Zealand’s currency has been so strong that officials are almost begging it to fall. Meanwhile, Japan’s trade weighted exchange rate is at its lowest since 1985.

Interest rate differentials remain the driving force for these moves, particularly for Japanese retail investors hungry for higher returns. Even though interest rates are beginning to rise in Japan – two-year bond yields have broken through 1 per cent for the first time in a decade – such levels pale beside New Zealand’s base rate of 7.75 per cent. But it is the expectation of future interest rate changes, rather than the absolute differential, that will determine future returns. Oddly, the New Zealand dollar has been rising despite weakness in its economy and muted inflation.

There is even more pressure on the BoJ to raise. I wouldnt be suprised to see 2 x .25% hikes before the end of 07

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Carry trade currencies

Published: June 6 2007 14:47 | Last updated: June 6 2007 14:47

Can conditions be any better for the yen carry trade? It seems not, if recent moves in the currency markets are anything to go by. The popular destination currencies for those borrowing yen at low interest rates are flying. The Australian dollar is now at an 18-year high against the US dollar. New Zealand’s currency has been so strong that officials are almost begging it to fall. Meanwhile, Japan’s trade weighted exchange rate is at its lowest since 1985.

Interest rate differentials remain the driving force for these moves, particularly for Japanese retail investors hungry for higher returns. Even though interest rates are beginning to rise in Japan – two-year bond yields have broken through 1 per cent for the first time in a decade – such levels pale beside New Zealand’s base rate of 7.75 per cent. But it is the expectation of future interest rate changes, rather than the absolute differential, that will determine future returns. Oddly, the New Zealand dollar has been rising despite weakness in its economy and muted inflation.

There is even more pressure on the BoJ to raise. I wouldnt be suprised to see 2 x .25% hikes before the end of 07

I think the carry trade will begin to run out of steam shortly. The New Zealand dollar did pay a visit to US0.59 18 months ago, even when Japan's interest rates were at 0% (and 7.25% in NZ). It is now at US0.75 and such dizzy levels are not tenable for the New Zealand economy in the long run. Aside from this, once investors start to believe the current bull run on equities and commodities is near an end, a sell-off will gather pace and the carry trade will be forced out, until the next major bull run. If the Swiss National Bank increase rates by 0.5% next week, it will be a serious kick in the proverbials for the carry trade and we may see people running for the exits sooner than we think. The Australian, New Zealand and Canadian dollars are all hovering around multi-decade highs right now but they have such a dependency on commodities that they could reverse direction very quickly and very sharply. The Canadian dollar has gone off the radar in the past 2 months and the cause is more than improving fundamentals. 80% of Canada's exports go to the US and their economy is effectively dead if that is threatened- the Canadian dollar has risen 11% against its US counterpart in the past 3 months. Any more of the same and direct intervention will be inevitable, before the Canadian economy is allowed to be crippled by the value of its own currency.

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Any more of the same and direct intervention will be inevitable, before the Canadian economy is allowed to be crippled by the value of its own currency.

But Canada needs interest rate rises to help cool the boom in the West. I don't see how they can cut rates when locals can barely afford to live in the West anymore as it is; my girlfriend's parents' house has tripled in value in about three years and is now totally unaffordable for an equivalent modern couple on local wages.

That said, it's still miles better than a house of the same price here in Surrey.

Edited by MarkG

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my girlfriend's parents' house has tripled in value in about three years

That would have to be Calgary then although I find a 200% increase a bit hard to believe. In toronto there has been drops if anything in the past 3 years.

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But Canada needs interest rate rises to help cool the boom in the West. I don't see how they can cut rates when locals can barely afford to live in the West anymore as it is; my girlfriend's parents' house has tripled in value in about three years and is now totally unaffordable for an equivalent modern couple on local wages.

That said, it's still miles better than a house of the same price here in Surrey.

Intervention would not be cutting rates. In fact rates are fully accepted to be rising to 4.5% in Canada in July.

Intervention would be verbal initially and if that did not work, the Bank of Canada could start to sell Canadian dollars on foreign exchange markets to drive the value of the currency down. It remains unlikely just yet, but if the Canadian dollar continues to rise sharply over the next few months, something will be done. The Bank of Canada themselves haven't helped matters. If it came to it in July, the Bank might refrain from rising rates as the market expects, leading to a sharp sell-off of the currency. A real correction might then permit them raise rates one meeting later.

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The Kiwi burped a little tonight. Let's see how it is doing today. Could this be a beginning? But then.

NZ central bank just used 150 million to create this hickup. Peanuts for the carry traders, I suppose.

As Sebastian said on another thread, possibly NZ will fall into a hole in the Antarctica anytime soon.

Edited by Goldfinger

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With the interest rates the way they are it is a very attractive deal. How far could these currencys fall against the Yen? Wont more people just pile back in if this hapens whilst interest rates difference exists?

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I am still surprised that the pound is so high against the Swiss Franc. There are interest rate increases planned here for later this year too (i live in Geneva) but the interest rate diferential is still huge. I cannot help feeling that the £ should be around 2.25 not 2.45 but even with such a change its just one and a half year's differential in interest rates.

Any thoughts from someone who knows much more than me ?

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