Yen Carry Trade again...

These are early signals how a choppy overseas market could cast a shadow on the Sensex in the coming days. And it may not be good news for the bulls, at least in the short-term. Yen — the currency in which international investors borrow to buy stocks across the world — is behaving strangely and this could trigger something what all markets fear: the unwinding of “yen carry trades”.

It can act on the markets like a double-edged sword: If yen rises against the dollar (which it has), investors find their borrowing cost go up (since they have to pay more yen to pay the interest on yen loans); this makes the investments less attractive and many are forced to unwind. In other words, they sell stocks to repay the yen loan. Such selling pressures unnerve the markets and the ripples touch emerging markets like India.

Interestingly, it can happen even when yen falls against the US dollar. “If yen keeps depreciating against dollar, people who have entered into carry trades at higher levels get a chance to book greater profits. Thus, the falling yen pushes such players towards booking profits,” said ICICI Bank chief economist Samiran Chakraborty.

The Japanese currency has fallen to 123.34 a dollar from 121.83 in the last month. However, it rose to a 3-month high on Wednesday. In the past couple of weeks, there has already been slight unwinding of “yen carry trade”, amid weakening of yen against dollar; this has fuelled a growing belief that yen’s downside could be limited hereon. (More so, given the widely shared perception that Bank of Japan will hike rate at least once this year). While the current liquidation has had no major impact on global equity markets, including India so far, some analysts are not ruling out such a possibility.

For years investors have taken advantage of the near-zero interest rate in Japan by borrowing yen, converting them into dollars or pounds and investing in higher-yielding assets including overseas equities.

Investors are already jittery about comments by Japan’s finance minister, indirectly warning against excess carry trades, and dropping hints at concern about the yen’s fall. In a note to investors, US-based Forex Capital Markets’ chief currency strategist, Kathy Lien said, “Comments from Japanese officials suggest that they may be facing increased pressure from overseas authorities to stem the slide in the yen. Now that yen weakness has taken off against the US dollar as well, the Japanese may be feeling the pressure from Washington.”

Industry officials expect yen carry trade to continue even if BoJ hikes rate because of the relatively higher returns in other markets. Kotak Mahindra Bank treasurer Mohan Shenoi said, “In my view, huge global liquidity will continue to support asset prices and hence yen carry trades will continue with marginal unwinding once in a way on issues such as the recent problems with sub-prime credits.”