Tuesday, October 5, 2010

Where's The Yen Carry Trade Now?

Three years ago I was shaking my head at the yen carry trade (As The Yen Strengthens).  Today's decision by the Bank of Japan to formally ZIRP (Zero Interest Rate Policy) itself into a corner, to - as it hopes - stop the yen from strengthening further, underscores how far the yen carry has unraveled since then.

This so-called "strategy" of borrowing yen at low interest rates to speculate in financial markets all over the world was one of the major generators of hot money and, thus, a big enabler of the bubble finance that ended up as The Crisis.

In August 2007 I estimated the size of yen-carry money at around $1 trillion, based on data from the Bank of International Settlements (BIS).  The updated chart below shows what has happened since then - I call it the rise and fall of the yen carry trade and it largely confirms my initial estimate of $1 trillion.  Notice how nominal amounts of yen FX swaps and forwards spiked upwards by about $1 trillion at the top of the bubble folly, only to come down by the same amount as soon as the bubble burst.

Data: BIS

I thought the yen carry trade to be so risky as to be downright foolish, at the time.  It made no sense to assume very high currency risk (the yen was at multi-year lows) in order to place highly leveraged bets on instruments providing very small spreads over Treasuries and over borrowing costs.  One example was buying second-tier European debt (e.g. Greek government bonds) at minuscule spreads of 50 basis points over bunds.  What followed is history, and it is still unfolding.

But now is now, and if I was a betting man - which of course I am, being in this business - I would be quite interested in putting on some new yen carry trades at this juncture.  

For the record,
  • JPY borrowing costs: essentially 0% (assuming, of course, that you can borrow at all).
  • Greek 10-year bond spreads over bunds: 800 bp
  • USD/JPY: 84


  1. I don't bet. I have never understood why people like to bet...
    A major failing on my part.

  2. Are you assuming that Greece will not default (or do a creditor haircut in the future)? Or are you talking about short term options (before the Sh.t hits the fan with defaults)?

    Just curious, my investment is all in a small farm property of my grandfather (with 3 sources of water, lots of trees,...)

  3. Tiago,

    Best you stick with the farm then and be tempted not by the sirens of (mis)fortune.

    But, for the record, Greece will not be allowed to default or do a haircut. There's simply too much at stake for everyone else in the EU, i.e. Germany and France, no matter how advantageous a debt reduction would be for Greek people.

  4. But can they (or should I say "we") pay? I agree with you on intention: they will not be allowed to default. But there is the issue of ability... Just imagine an interest spike coupled with low maturities...

  5. Hey, Tiago, you've got a GREAT INVESTMENT there....

  6. OT:

    I ran across this post regarding.. Since we've had such a lively discussion on this matter, I thought I'd post this link.....




  7. Well, well, well, so the featured book is "Animal Spirits", huh ?
    It looks like the authors picked up some of my ideas FROM SOMEWHERE.
    (Unlike MANY PEOPLE THESE DAYS I've made a MAJOR INVESTMENT IN GRATUITY. Some unforgiving people could argue that I made it under the duress of not being able to money my talents (French expression for "sell") but I try to be as magnanimous as possible).
    As it turns out... the "psychological" point of view is a... debased currency in my book.
    Freud was NOT a psychologist. He was a PSYCHOANALYST. Big difference there. In my book, and with the historical perspective that Freud just couldn't have at the time. (but it would be rather stupid to accuse Galileo of not discovering quantum physics, now, wouldn't it ? hope I didn't mess up there. I am so NULLE in physics...)
    Because the psychological point of view on the problem REMAINS an overridingly OBJECTIFYING one, and objectivation is THE major problem in our civilization at this time.
    Don't tell me that because a handful of physicists have discovered.. fractals that the general public has given up on "objectivity", because.. I won't believe you.
    When I think about what USE the psychologists are put to in... military torture protocols, management.. TORTURE protocols, advertising campaigns, etc etc, I reject the psychological POINT OF VIEW of the world. Incompatible with the point of view of the world I wish to cultivate IN MYSELF, and my relations with others.
    I know this MAY sound very radical but... those fractals seem to suggest that a return to the VALUES of subjectivity in our society might be beneficial for all of us.

  8. Debra:

    "Animal spirits" is concept of Keynesianism, in case you didn't know.

  9. No, I didn't know, but you just told me. ;-) Thanks.
    I noticed the mention of Keynes on the virtual dust jacket. One of the only economists to even acknowledge the existence of psychology until relatively recently. But, don't think I'm going to do any apology for psychology. See above.

  10. I'm spending a quiet evening at home with the pups, Ben, Olive and The Bug....

    Just relaxing and kinda surfing the web...... In case you didn't see it I came across this on the PBS Frontline site... It'll take about an hour to watch.... I thought it was a well done, entertaining and very telling story....

    If you haven't seen The Warning, open a nice bottle of wine and enjoy....


    My best regards,


  11. do you think this exchange rate of 81 USD/JPY is remotely representing anything but pushing on a string while the Fed preps the next round of QE?
    i can hardly see a justification for such a strong yen, given the inevitable prospects for ZIRP forever in japan and for as long as benito is at the Fed as well. anyways, sooner or later the paths of both countries will diverge and japan will have to print more and more and he U.S. will have to begin raising rates.