The Japanese Yen Surges Due to Carry Trade Unwinding

Yen Gains as Global Tech Stocks Fall, Safe-Haven Demand Rises

The Japanese yen rose broadly during Asian market trading on Thursday against a basket of global currencies, extending its strong gains for the fourth consecutive day against the US dollar, reaching its highest level in two and a half months. This rise is driven by the acceleration of unwinding "carry trade" positions ahead of the Bank of Japan meeting and the full pricing of expectations for a US interest rate cut in September.

These gains are also supported by the increasing demand for the yen as a safe-haven asset amid a sharp decline in global tech stocks.

Amid a sense of relief over the sharp recovery in the local currency, Japanese government officials have refrained from commenting on the current movements of the yen in the foreign exchange market.

Price Overview

• Yen Exchange Rate Today: The dollar fell against the yen by 1.05% to (¥152.23), the lowest since May 3, from the opening price of (¥153.85), and recorded the highest level at (¥153.97).
• The yen rose by 1.1% against the US dollar on Wednesday, marking the third consecutive daily gain and the biggest daily gain since July 17, amid accelerating covering of large short positions.

What is Carry Trade?

Carry trade is one of the best and most important strategies relied upon by many experts and traders in the world of trading. It is a way to build long-term trading positions to benefit from the interest rate differentials between currencies in the forex market.

Carry trade transactions in the forex market involve selling a low-yield currency and buying a high-yield currency while financing the trading position on a daily, weekly, or any other period chosen by the trader, allowing them to benefit from the interest rate differential.

The low-yield currency is called the "funding currency," and the high-yield currency is the "carry currency." In the USD/JPY pair, the carry currency is the US dollar, and the funding currency is the Japanese yen.

Traders borrow yen (low-yield) via forward points daily or weekly or any other period chosen by the trader, then lend the US dollar (high-yield) via forward points.

If we assume that the returns of the low-yield currency will continue to decline or the returns of the high-yield currency will continue to rise, then financing this trade on a daily basis is an easy way to make profits.

Unwinding Carry Trade Positions

Currently, the unwinding of long-term carry trade positions on the Japanese yen is accelerating due to strong speculation around the Bank of Japan's monetary policy meeting scheduled for next week.

Sources told Reuters that the Bank of Japan is likely to discuss whether to raise interest rates and unveil a plan to halve bond purchases over the coming years, indicating its intention to gradually withdraw from its massive monetary stimulus.

In contrast, weak economic data on industrial activity in the United States during July raised the probability of the Federal Reserve cutting US interest rates by 25 basis points in September from 94% to 100% and in November from 98% to 100%.

Thus, the Bank of Japan is about to take new steps towards normalizing monetary policy for the world's third-largest economy, while the Federal Reserve is nearing easing monetary policy and starting a cycle of US interest rate cuts.

Safe-Haven Demand

Strong gains in the Japanese yen are currently supported by the purchase of the currency as a safe haven amid the sharp decline in tech stocks globally.

Japanese Authorities

Japanese Finance Minister Shunichi Suzuki and top currency diplomat Masato Kanda refrained from commenting on foreign exchange rates on Wednesday as the yen rose broadly against a basket of global currencies.

When asked about the recent sharp rise in the yen, Suzuki said he would refrain from commenting, noting that doing so "could have unexpected effects on the market."

Kanda, Deputy Minister of Finance for International Affairs, echoed Suzuki's remarks about unexpected effects when asked if the speculative moves previously blamed for the yen's weakness had subsided.

Kanda said that foreign exchange was not on the agenda of the G7 meeting on Wednesday but added, "As the G7, we discuss the issue routinely."

Sources familiar with the matter said Japan would seek to reaffirm at the G20 meeting the previously agreed commitments that exchange rates should reflect underlying economic fundamentals.

Some politicians have called on the Bank of Japan to provide more clarity on its plan to raise interest rates partially to prevent the yen from testing new lows against the dollar, adding pressure on the central bank.

While a weak yen boosts exports, it has become a concern for policymakers by raising import costs and hurting consumption.

Yen Performance Outlook

• Tony Sycamore, market analyst at IG, said: "The threat of reducing Japanese government bond purchases and raising interest rates certainly raises the concern we've seen there in different yen pairs, especially the USD/JPY pair."
• Sycamore added: "The yen is also helped by deteriorating risk appetite. I think it's just a perfect storm at this time."
• Sycamore explained: "There is a dismantling of yen carry trades and a sharp decline in tech trade across most global markets."