Yen–USD Carry Trade Unleashed: Where Opportunity Meets Risk

Good Morning Ladies and Gentlemen

”I’d rather be an optimist and a fool than a pessimist and right.”

Albert Einstein

Politicians often grant loyalty to corporations, which can result in rewards or penalties based on political cycles. Being linked to a particular politician may invite regulatory scrutiny or retaliation as political dynamics change. This topic appears intriguing enough for further exploration, and I plan to share my thoughts on it in my upcoming “Stefan’s Weekly.”

The Carry Trade: A Definition

Ladies and Gentlemen, a carry trade is a trading strategy in which an investor borrows funds at a lower interest rate to invest in assets that offer potentially higher returns. This approach often exploits interest rate differentials between two currencies, enabling traders to profit from the spread. Carry trades are especially popular in the forex market, where traders seek to capitalise on the differences in interest rates between currencies.

The Carry Trade: A Classic

The classic carry trade in financial markets is shorting the yen while going long on the USD (either bonds or equities).  Therefore, the yen carry trade works when a trader borrows yen, converts the funds into dollars, and invests in higher-yielding U.S. government bonds or U.S. equities. It is effective only if the interest rate differential between Japan and the US either widens or remains stable. So far, so good.

The Carry Trade: A Danger

However, currently, this differential is narrowing. Additionally, if the dollar/yen exchange rate declines (indicating a strengthening yen), taking a short yen position may not be advisable. In such cases, the cost of repaying loans in yen increases. This decline in the dollar/yen exchange rate can be further intensified by panic, as feedback effects may compel buyers of yen loans to cover their positions. With this context in mind, the question arises: what is the scale of the yen carry trade? Recent data from the Bank for International Settlements (BIS) indicates that open positions exceed USD 260 billion. While this figure is substantial, it pales in comparison with exaggerated claims from less credible online media sources, which have reported figures as high as USD 20 trillion.

The Carry Trade: A Reversal

The reversal of a carry trade could adversely affect the U.S. dollar, interest rates, and stock markets. The USD would most likely decline, as would equity markets, and interest rates would likely rise. All of this, of course, only if the U.S. Treasury Department does not intervene.

The Carry Trade: Additional Noise

The Danish pension fund Akademiker Pension (https://akademikerpension.dk/) announced last Tuesday that it plans to divest approximately USD 100 million in US government bonds by the end of the month. Chief Investment Officer Anders Schel-de stated that the decision stems from concerns about the deteriorating state of US public finances, prompting the fund to explore alternative strategies to manage liquidity and risk. While the move is not directly tied to the ongoing dispute between Denmark and the US regarding Greenland, Schelde noted, “Of course, that didn’t make the decision any easier.” Following this announcement, a report indicated that the large Swedish pension fund Alecta (https://www.alecta.se/this-is-alecta) acted the next day similarly, selling a significant portion of US government securities due to perceived political risks. The volume of Alecta’s sale is reported to be between USD 7.7 billion and USD 8.8 billion.

White House Reaction

There appears to be a growing unease, as the U.S. President has cautioned European nations about the potential need to sell U.S. bonds on a substantial scale. I believe this approach is understandable but unsustainable. Firstly, former allies may remember these threats and feel compelled to implement defensive strategies. More importantly, this tactic fails to address the fundamental issue of persistent budget deficits and the United States’ ever-increasing national debt.

Ladies and Gentlemen

Feel free to send your messages to smk@incrementum.li. Many thanks, indeed!

I wish you an excellent start to the day and weekend!

Yours truly,

Stefan M. Kremeth
CEO & Head of Wealth Management
Incrementum AG – we love managing assets

Tel.: +423 237 26 60
Cell: +41 79 303 48 39
Im alten Riet 153
9494 Schaan/Liechtenstein
Mail: smk@incrementum.li