Ray V and Tom Westbrook
SINGAPORE (Reuters) – The era of negative rates in Japan may be over, but some investors are convinced low rates are not over yet, meaning rates against the yen are back despite the Bank of Japan’s first hike in 17 years.
While the Bank of Japan’s decision at Tuesday’s policy meeting marked a monumental shift, it maintained its dovish tone and said it expected to maintain “comfortable financial conditions.”
That prompted traders to return to popular yen carry trades, sending the already battered yen even lower.
“Japan continues to have the lowest interest rate among G10 countries,” said Shafali Sachdev, head of investment services for Asia at BNP Paribas (OTC:) Wealth Management.
“So with event risk removed, it’s almost seen as an opportunity to re-enter carry positions.”
In a carry trade, an investor takes out a loan in a currency with low interest rates and invests the proceeds in a higher-yielding currency. A three-month dollar-yen carry trade could yield up to 5% annualized gains.
The rush to borrow the yen for carry trades was clearly reflected in the price action on Wednesday.
The yen fell to its lowest level in four months against the dollar, a 16-year low against the euro and its weakest against sterling since 2015, extending its decline from the previous session.
EXCELLENT YIELD
Part of the yen’s fall came amid a “selling the facts” deal, given how Bank of Japan Governor Kazuo Ueda, unlike his predecessor Haruhiko Kuroda, who took a “shock and awe” approach, prepared investors for the potential move.
“What historically would have been a very seismic announcement ended up being quite muted given what has already trickled into the markets over the past few days,” said Charles Hepworth, investment director at GAM Investments.
Moreover, there is still a huge gap between rates in Japan and other developed countries. The US Federal Reserve’s main rate is at 5.25-5.5%, and rates in other major economies also remain above 4%.
This sharp difference is keeping the yen in positive territory, and the currency, in turn, is under pressure. The currency has fallen 16% against the dollar since its peak in January 2023.
“The big pairs continue to trade against the dollar, against the 0, against… These are shorter-term trades where the carry is in your favor,” said Sachdev of BNP Paribas.
And with volatility relatively low and the Fed unlikely to begin a rate easing cycle anytime soon, it’s easy to see why investors are eager to accumulate yen-funded positions.
Three-month implied volatility of the dollar versus the yen, a measure of the value of options contracts that traders use to hedge positions, was near its lowest level in about three months.
Market expectations for the Fed’s first rate cut in June were also lowered following data showing still-persistent inflation in the world’s largest economy.
“Whenever the Fed and the Bank of Japan change policy settings around the same time, it is the Fed that controls and dominates the price action,” said Gareth Berry, FX and rates strategist at Macquarie Group (OTC:).
HSBC analysts believe the yen selling will eventually subside as the Fed starts cutting rates. If the dollar falls and the yen strengthens, the profitability of carry trades on the yen will be reduced.
But at the moment, even a significant turn in the policy of the Bank of Japan could not turn the situation in favor of the yen.