Unwinding of the Yen Carry Trade

I've been reading about the Yen carry trade for years and there has been much talk about when this would unwind. The scope of this borrowing in Yen and investing elsewhere in the world is unknown but thought to be very large. Much of the capital flow over the last few years has been into the American markets including government Treasuries, mortgage backed securities, as well as stocks. As the American markets increase in volatility, there is usually an increase in the value of the Yen, as funds and hedgies who are involved in this carry trade unwind their leveraged positions.

As the Cdn dollar, Euro and British pound have risen in the last few weeks especially, I have noticed that the Yen was steady at 114-116, despite the huge run ups in most other currencies that float vs. the US dollar. The last time the Yen broached 111 was during the first credit crunch in August. The Japanese are well known for their currency manipulations in the market.

I decided to check this correlation out and when I charted FXY (an ETF that tracks the Yen/dollar exchange) versus the S&P500 (top chart), there was an amazing negative correlation. I couldn't chart this back more than a year because I think the FXY hasn't been around that long. So the blue line is the S&P500 and the red line is the FXY Currency Shares Japanese Yen Trust. This was a 6 month chart. I also ran a chart of the S&P versus a different US dollar/Yen index (bottom chart) but there wasn't any specific symbol for this index as I think it is some index and not tradable but it has a longer price level history. Unfortunately I think this US dollar/Yen index has the numerator and denominator the other way around as compared to FXY because there is a good correlation positively.



Now, the Yen carry trade is a known phenomenon but I believe this correlation is profitable because the capital flows in the currency markets are so large that it is hard to arbitrage.

The other macro themes are in line for a higher Yen as well. The Fed appears to be penned into an easing mode which lessens the interest rate arbitrage between the US and Japan. The markets seem to be exhibiting higher volatility.

Even if only as a hedge against US stock exposure as well as US currency exposure, I think FXY has merit.

Des