(Bloomberg) — BNY said there is still room for further unwinding of yen-financed carry trades, with the Japanese currency potentially rising toward 100 per dollar over time.
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Investors are still too pessimistic about the yen and short positions will continue to be unwound, said Bob Savage, the firm’s chief market strategy and insights officer. Analysis shows the yen is too cheap at its current level of 147 and that its fair value should move closer to 100 over time, he wrote in a note.
“Expect the pain for yen shorts to continue for weeks, if not months,” Savage wrote. “Further risk reduction will follow and August will remain a highly volatile month.”
Markets have had a rollercoaster week as traders rushed to dump short yen bets on U.S. recession fears and bets that the Bank of Japan will raise interest rates further. As the epic swings of the past few days subside, investors are fixated on whether and when the next round of carry strategies can shake markets again.
The short positions were built up in recent years as traders took advantage of the BOJ’s ultra-loose monetary policy to borrow the yen and buy higher-yielding assets elsewhere. The strategy helped push the currency to its weakest point since the 1980s and prompted official intervention to prop it up in July.
Yen-funded trades in a basket of eight emerging market currencies tracked by Bloomberg had given investors a total return of just over 17% this year through early July, just before the strategy ruptured. The rout saw it wipe out nearly all of its year-to-date gains, according to data compiled by Bloomberg.
Not all Wall Street banks are affiliated with BNY. JPMorgan Chase & Co. says it is three-quarters through the unwinding of the carry, while Citigroup Inc. says its strategy is out of the woods and that the focus should be on squeezing the Chinese yuan.
Savage believes it is wrong to assume the BOJ is targeting a new range of 130-150 per dollar for the yen, as economic data from the US and Japan can diverge.
“Given the current environment, it will take many months for the yen to return to a fair value,” he wrote. “This makes the U.S. elections and the U.S. business and credit cycles crucial, along with Japan and its own economic growth.”
(Updates with yen-financed carry trade returns and chart.)
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