Yen could be used to fund carry trades as Fed tapers

Thu Dec 12, 2013 4:00pm EST

* BOJ stance likely to keep pressure on yen, rates low

* Yen's gains mostly vs major currencies, not high yielders

* Dollar/yen volatility still well below 2013 highs

By Lisa Twaronite

TOKYO, Dec 13 (Reuters) - The Bank of Japan's commitment to ultra-easy monetary policy has revived the appeal of the yen to fund investments in higher-yielding assets, though analysts and market participants say the so-called yen carry trade has yet to catch fire.

Japan's rock-bottom interest rates, thanks to the BOJ's policies, made the yen the darling of investors seeking to put on carry trades in the mid-2000s, until the financial crisis of 2008 brought an era of lower global rates.

With the U.S. Federal Reserve now poised to begin tapering its stimulus even as the BOJ considers additional easing measures, the yen could be a source of global funding again, provided that volatility stays low.

Recent yen-short positioning suggests to some that the yen might be making a comeback as a source of funding. Speculators' net yen short positions stood at 133,383 contracts last week, the highest level since June 2007 and up from 90,326 a year ago.

"On the face of it, the large increase in market short positioning suggests that the yen is being increasingly used as a carry-trade funding currency," said Mitul Kotecha, global head of FX strategy at Credit Agricole in Hong Kong.

But Kotecha and others note that much of the gains against the yen this year have been registered by major currencies, such as the euro, Swiss franc, and pound, and not the usual high-yielding carry-trade candidates.

"I think every time someone shorts the yen, someone else claims it is a carry trade. If it is carry trade, it is very unusual as it does not appear to be benefiting the high-yielding currencies, including Japan's favourites, like Australia, South Africa, Brazil or Turkey," said Marc Chandler, global head of currency strategy Brown Brothers Harriman in New York.

The dollar has gained more than 18 percent against the yen this year, while the euro has risen more than 23 percent, as of Thursday in Asia. By contrast, the Aussie and the Brazilian real have each gained less than 4 percent against the Japanese unit.

NEW ZEALAND EXCEPTION

One exception is the New Zealand dollar, which has rallied more than 18 percent against the yen against a backdrop of expectations that the Reserve Bank of New Zealand will hike rates from a record low 2.5 percent.

But those yield differentials remain well below those in the heyday of the carry trade, when rates in the developed world were mostly at or above 4 percent, while Japan's wallowed close to zero.

Implied volatilities on dollar/yen options have crept up in recent weeks but are well off this year's highs. One-month volatility stood around 9 percent, up from a 10-month low plumbed at the end of October but far below a two-year high of 18.75 percent hit on June 13.

Japan is not explicitly seeking a weaker yen, but a drop in its currency is a natural side-effect of government policies and the BOJ's efforts to stimulate growth and meet a target of 2 percent inflation within two years, while cushioning any blow from a hike in the country's sale tax next year.

Bureaucrats in the BOJ are actively game-planning scenarios for further easing, according to officials briefed on the process.

Whether the yen musters a command performance as a carry-trade funding star, most strategists say the BOJ's policies will keep pressure on the Japanese unit in the months ahead.

"The yen's weakness looks guaranteed as heavy speculative forces wagering against it resume with conviction," said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York.

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