Amid much hubbub, it looks as though foreign exchange traders’ much-vaunted “carry trade” practice is coming back, notes John Authers in his Short View column in the FT.
Late last month and early this, the yen appreciated sharply against a range of currencies, inflicting losses on carry traders. The yen’s renewed weakening since then has seen a return to relative stability. Against the NZ dollar, the yen strengthened by 10 per cent at one point, and has now weakened by 5.7 per cent from there. Against the euro it strengthened by 5.5 per cent, and has dropped by 3 per cent. That makes carry trades appealing once more.
Because markets have worked on the belief that carry-trade cash is widely perceived as a support for valuations of other assets, equities have been tightly correlated to shifts in the yen. Why might the carry trade return? The Bank of Japan’s decision to keep interest rates at their low level certainly helps. So did the surprise in the UK inflation data, which increased the chances of rate rises from the Bank of England and thereby strengthened sterling.
However, the turmoil in forex markets is not yet over. The yen rose sharply on Tuesday on news that the People’s Bank of China would diversify some of its huge holdings of dollars. This was not accompanied by a sell-off in US equities, so the high correlations between asset classes while uncertainty was at its peak are receding again.
Nevertheless, equity traders are less worried about the carry trade than a week ago. History supports them. Alan Ruskin of RBS Greenwich Capital shows that compared with past shake-outs, the fall in global equities has already been bigger than in previous episodes. The bulk of the sell-off in equities, after the past five times a carry trade was rudely interrupted, was over within 15 trading days - a point we have now reached.
