Analysis: the Japanese yen becomes a financing currency again, but with more risks

HONG KONG, Feb 15 (Reuters) – As the Bank of Japan asserts its position as a lone dove among its peers, the yen is regaining its status as the world’s most popular funding currency.

The trade is risky, however, as the yen could once again become a safe haven if tensions over Ukraine escalate or an aggressive Federal Reserve triggers a sell-off in markets.

The conventional role of the yen as a cheap currency that investors could borrow and use to fund “carry” trades in higher-yielding markets has been diluted somewhat during the coronavirus pandemic, as other central banks also cut their rates to zero.

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But it once again became the preferred funding currency this week after the BOJ announced a special bond-buying operation to remind markets of its commitment to keeping yields low for longer.

This stance is at odds with the Fed and European central banks which have become decidedly hawkish about inflation.

“If you’re an investor in London or Hong Kong and you’re thinking about what currency to fund a transaction with, you’re basically left with one central bank…at least for now,” Ben said. Shatil. , a Tokyo-based FX strategist at JPMorgan.

“And it’s an environment that has generally favored the yen as a funding currency for carry trades.”

Some things haven’t changed for the yen. Japan has one of the weakest currencies among the Group of Seven countries, sub-zero short-term rates and a base of domestic investors desperate for yield overseas.

Yet, Ukraine factor aside, shorting the yen has become a riskier transaction.

The prospect of higher energy prices and imported inflation could force the BOJ to raise rates. An associated risk is that the Fed goes too fast and too far with its tightening policy, causing a global sell-off in the markets which generates flows towards the safe-haven yen.

In a typical carry trade, investors borrow the low yielding yen or Swiss franc to invest in higher yielding assets elsewhere. The stability of the funding currency is essential to keep the cost of the transaction low.

In a deflation-ridden Japan, short-term yen deposit rates have been close to zero for decades, and negative since 2016, when the BOJ adopted its yield curve control policy.

An example of a typical carry trade would be to borrow yen to invest in Brazilian money markets. This trade has returned 10.7% annualized so far this year.

Paul Mackel, global head of FX at HSBC, says investors can return to the yen as the funding currency of choice, but it’s risky.

“A carry trade will never be very smooth, it’s always about picking up pennies in front of the steamroller, but that steamroller may be a little closer given those uncertainties associated with political risk,” Mackel said.


As the United States warns of an acceleration in the build-up of Russian forces on the Ukrainian border, the yen rose.

After testing its more than four-year low at 116.33 on the dollar last week, it strengthened strongly to 115.33. This type of rapid appreciation erodes carry trades, most of which involve shorting the funding currency.

“The safe-haven properties of the yen can accelerate very quickly,” Mackel said.

There are also fears that Japanese policymakers will worry about the economic impact of a weak yen, especially as the country imports most of its energy and oil prices have hit seven-year highs.

Inflation has edged closer to the BOJ’s 2% policy target, raising the odds that the BOJ will loosen its grip on yields and that rising yields will torpedo yen-funded trades.

The BOJ leaves the markets guessing. While he offered to buy an unlimited number of bonds this week to underscore his determination to contain domestic borrowing costs, he made it clear that such offers would only be made sporadically. Read more

For now, investors are buying into the dovish view.

The BOJ’s offer to buy bonds, “in the near term will likely quiet what was a pretty loud chorus of people saying the BOJ would give in on yield curve control,” JPMorgan’s Shatil said.

This “creates a track for a bit of yen weakness, which would be helpful in the context of these carry trades.”

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Editing by Vidya Ranganathan and Jacqueline Wong

Our standards: The Thomson Reuters Trust Principles.

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