As Japanese yen sinks to a 40-year low, focus turns to the carry trade

As the Japanese yen sinks to a four-decade low, analysts are paying close attention to one of the world’s most influential drivers of global capital flows: the yen carry trade.

While the macro backdrop continues to support the strategy – in which investors borrow cheaply in yen to finance higher-yielding investments overseas – the focus is now on how long those conditions can persist, and what could happen if they eventually reverse.

Bosco Wu, an investment strategist at Bank of East Asia, said such trade had been underpinned by a wide US-Japan interest rate differential, noting that the two-year interest rate swap spread between the two countries had expanded to around 250 basis points.

“This gap remains large enough to be economically meaningful and should continue to drive a structural outflow of capital from Japan, supporting yen-funded carry trades,” said Wu, who added that high-yielding US assets remained an important destination for this liquidity.

His comments came as the yen slid past 162 per US dollar – its weakest level since 1986 – with persistent hawkish expectations for the US Federal Reserve and the Bank of Japan’s (BOJ’s) gradual approach to policy tightening keeping the US-Japan interest rate differential wide.

“With US inflation likely to remain elevated through most of the third quarter, we expect the Federal Reserve to maintain a hawkish stance even if it does not ultimately raise rates again,” said Cliff Zhao, chief economist at CCB International in Hong Kong, and the bank’s global strategist Vera Jiang.