* Yen-funded carry trade talk resurfaces as yen slides
* Old carry favourite Aussie makes way for emerging FX
* Carry trade unlikely to return to pre-crisis levels
* Investors wary of U.S. fiscal cliff, bleak global economy
By Anooja Debnath
LONDON, Nov 29 Expectations of easier monetary policy in Japan, along with a weaker yen, have revived talk of yen-funded carry trades, with investments in some emerging market currencies seen as most attractive.
Strategists said the prospect of selling the weak and low-interest rate yen for higher returns elsewhere could provide a final money-making opportunity of 2012 for banks' trading desks and macro funds, which have struggled in an uncertain global environment where few are willing to take on risk.
With depressed interest rates and bleak economic outlooks in many developed countries, investors looking to sell the yen are increasingly focusing on currencies from emerging markets in Asia, Europe and Latin America with higher interest rates, relatively better fiscal positions and robust growth prospects.
The yen shed around 4 percent against the U.S. dollar in the week after Nov. 14, when talk surfaced of an early election in Japan, raising the prospect of a new government pushing the BOJ into easing its ultra-loose monetary policy.
The yen's trade-weighted value, an index calculated against a basket of developed and emerging currencies, has fallen to a near eight-month low, data showed.
"Using the yen (as a funding currency) has made sense in the last 6-7 months, but the question is, 'What do you buy?'," said Peter Kinsella, FX strategist with Commerzbank.
"Trying to find decent carry currencies with reasonably solid fiscal dynamics and with a generally positive story is difficult."
With volatility subdued, riskier and less liquid emerging market currencies are increasingly targeted by investors as they tentatively return to leveraged carry trades.
"With the fall in volatility, conditions are definitely in place for carry to come back, but perhaps in the emerging market space," said Geoff Kendrick, currency analyst at Nomura.
Indeed, while the yen has fallen to its lowest in nearly eight months against the high-yielding Australian dollar and the New Zealand dollar, it hit its weakest in 17 months against the South Korean won.
If Japan were to ease policy, yield-hungry Japanese retail investors and asset managers could give such trades a boost.
Before the financial crisis, near-zero rates in Japan saw these investors sell the yen to buy the Australian or New Zealand dollar, whose interest rates were around 7 percent.
Both those countries have since slashed rates. Australia's official cash rate stands at 3.25 percent and the central bank is expected to cut in coming months, a factor likely to keep investors away from the Aussie.
Morgan Stanley strategists recommend selling the yen against a basket of Chinese yuan, Korean won, Taiwanese dollar and the Singapore dollar.
Some money managers have already waded in.
"We are adding the Korean won, the Malaysian ringitt and looking at the Turkish lira while selling the yen," said Stuart Frost, fund manager at RWC Capital.
LIMITED COME BACK IN CARRY
Investors, though, would be hesitant to make large carry trades with the euro zone debt crisis and, particularly, the U.S. "fiscal cliff" unresolved.
Most investors expect U.S. lawmakers to solve the problem, but if no deal is reached, the world's largest economy could be headed for a recession. That would see investors return to safe-haven currencies like the yen.
"One can see why people are dipping their toes into carry trades but I doubt they are fully going to set major positions for 2013 until the (fiscal) issue is resolved," said Chris Turner, head of FX strategy at ING.
"If progress can't be made by year-end or worse even, U.S. Treasuries are downgraded by ratings agencies, that would really upset the carry trade."
Despite the trigger of the yen's recent slide, the volume of carry trades is unlikely to hit levels seen before the fall of U.S. investment bank Lehman Brothers in 2008.
Bets against the yen placed by speculators are at just a third of the some $19 billion worth of net yen shorts in late June 2007. Also, the dollar trades at around 82 yen, a long way from the 120 yen levels seen in 2007.
"The stars are lined up for a slightly weaker yen but I wouldn't expect to see a very large scale reversion to the carry trade that was of the sort we saw in the 2005-07 period," said Colin Asher, senior economist at Mizuho Corporate Bank.
"You might see a much more moderate version."