The notorious Yen Carry Trade (YCT) has been cheering up the investors en masse till date. However, the aggravating misery on Wall Street, US recession woes and the recent dollar tumble could spell trouble for YCT. This article discusses the issue.

WIn the past couple of months, apart from the weakening of the US economy, a massive unwinding of the Yen Carry Trade (YCT) has put a big damper on the world equity markets. Carry trade refers to the strategy where investors borrow currency in Japan (such as yen) at low interest rates and sell or invest the currency into liquid financial assets in a country offering a higher interest rate. The growth of YCT weakens the yen since so many investors sell yen and strengthen the high yielding currency. However, if the carry trade unwinds, the yen will reach new heights against a wide basket of currencies. Dealers say that the victims can include individuals, corporates and hedge funds. Recently, the yen was at a 12-year high against the greenback which was is on a decline owing to US economic woes. Tokyo-based economists speculate that any implosion in carry trade can have devastating effects on the $1 tn overseas investments of Japanese mutual funds by individual investors, thereby forcing them to unwind carry trades.

The YCT is a `cheap money' ploy that devastates the extremely low interest rates or borrowing rates in Japan. However it carries increased leverage and this is leading to risk in a higher-yield asset class. The carry trade activity is highly sensitive to foreign exchange moves and liquidity fears. After the technology bubble burst in 2000 and 9/11 attacks on the US, the steep interest rate cut has amplified carry trades. Back then, the Japanese interest rates ruled at zero per cent. Even now, the official interest rates in Japan, rule at a steady 0.50%, far cheaper than the price at which money has been readily available to borrow elsewhere.

The carry trade investors (local and foreign) thus exploited the near-zero interest rates and invested the borrowed money into higher-yielding bonds and equities. The country was struggling with deflation and leveraging the yen offered gains to anybody wanting to tap liquidity in the market. Also, because many carry trades were done off the balance sheet, it was difficult to measure the exact size and there was no available data on the global carry trade. Investors usually purchase in the bond markets, especially the US government bonds, which could be bought on tiny margins. Besides, carry-trade aficionados had become eager adopters of the YCT.

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