Surging yen upends popular global FX carry trades

By Alun John, Harry Robertson, Tom Westbrook

LONDON/SINGAPORE (Reuters) -A perfect storm of political, policy and technical risks has upended one of the year's most popular currency trades, sending the Japanese yen soaring from 38-year lows with ripples spreading as far as Switzerland, Australia and Mexico. 

Nearly $40 billion in suspected intervention by Japanese authorities ignited the yen's rally but the move has taken on a life of its own, upending the carry trades which exploit differences in interest rates and often utilise the currency. 

The yen has surged from around 162 per dollar in mid July to roughly 153 per dollar, its biggest two week gain of the year, even if it remains this 2024's worst performing G10 currency.

"The yen is a classic example of where positioning and top-down factors are aligning," said Hugh Gimber, global market strategist at JPMorgan Asset Management. 

Analysts point to expectations that the yawning gap between U.S. and Japanese interest rates could soon narrow, as well as concerns that a Donald Trump victory in November's U.S. presidential election could unleash new currency wars.

Speculators have cut their bearish bets against the yen by the most in a month since March 2020. At $8.61 billion, the net short position is 40% below April's near-seven year high, according to data from the U.S. markets regulator.

"Because this unwinding of short yen positioning is correlated with the so-called carry trade it can affect other carry positions as well," said Athanasios Vamvakidis, global head of G10 FX strategy at Bank of America.

STEAMROLLER

Carry trades have proved hugely popular this year and last, fuelled by a combination of low volatility and big differences between central bank interest rates.

Traders borrowed in yen or Swiss francs at rock-bottom rates and invested in assets with higher returns such as Mexican government bonds or even U.S. tech stocks, with analysts saying last week's equity-market rout may have got an extra kick from some carry trades unwinding. 

Benchmark 10-year borrowing costs are around 1% in Japan and 0.5% in Switzerland versus more than 4% in Australia - popular with developed-market carry traders - or near 10% in Mexico. 

The recent pick up in volatility has added pressure to carry trades that did well in the more benign markets of the first half of 2024, said Nathan Swami, head of currency trading at Citi in Singapore

"Carry trades involving funding in yen appear to be increasingly vulnerable to VaR shocks, similar to what we saw last week," he said. 

A VaR shock is essentially a jump in the maximum loss an investment can sustain over a period of time.

The resulting shifts are felt far and wide.

The Swiss franc and China's offshore yuan, other popular carry trade funding currencies, also appreciated last week, with the yuan seeing its biggest weekly gain against the dollar since April, and the franc hitting its strongest since March..

"It's all about carry trades. You can see from the daily moves in say the Swiss franc, when the news isn't to do with the franc but the yen," said Jamie Niven, senior fixed income portfolio manager at Candriam. 

Niven said he began reducing a short position in China's yuan last week, as its sudden appreciation made him wary of carry-trade currencies. 

Meanwhile, the Australian dollar has fallen 3.6% against the U.S. dollar in two weeks, and nearly 6% on the yen, its most in a fortnight since the pandemic volatility of March 2020. 

Latin American currencies like the Mexican peso are also softer.

"It's not a pure carry environment for the moment," said Andreas Koenig, head of global FX at Amundi, Europe's largest asset manager, noting that the recent daily moves in currencies like the peso can easily wipe out any gains from carry.    

The surprise outcome of the Mexican election in June also jolted carry trades, while the U.S. vote and uncertainty about the trajectory of central bank policy are likely to drive further currency volatility, deterring investors from carry trades for now.

"When uncertainty goes up and we're coming closer to big events, like U.S. elections, I would say I would wait until these are out," said Koenig. 

"Afterwards," Koenig added, "I'm pretty sure a lot of opportunities can open up, especially let's say on the Mexican side."

(Reporting by Alun John and Harry Robertson in London, and Tom Westbrook in Singapore, editing by Amanda Cooper and Kirsten Donovan)