LONDON: Defining the size of the yen carry trade remains an elusive art, despite the fact it has drawn so much comment, sparked so much debate and been cited as a major factor behind last week’s global market upheaval.
Japan’s top financial diplomat last week guessed that investors might have borrowed between 10 and 20 trillion yen (Rs3,82,660 crore and Rs7,65,347 crore) — at current exchange rates, anywhere between $85 and $170 billion dollars — to buy higher-yielding assets.
Some market estimates suggest a figure in excess of $200 billion. But because there’s really no way knowing for sure how big investors’ bets against the low-yielding yen really are, Hiroshi Watanabe’s guess may be as accurate as any.
While Watanabe and other Japanese officials have consistently played down the potential threat of carry trade unwinding, other Group of Seven policymakers — mainly Europeans — have expressed more concern.
They’ve highlighted unease over two developing phenomena in global financial markets: the masking of market risk thanks to the increasingly opaque world of hedge fund activity, and ballooning carry trades. The two may not be unconnected.
Still, there are few currency market experts bold enough to put a number on how big the carry trade really is.
“It’s the Holy Grail,” said Neil Mellor, currency strategist at The Bank of New York, the world’s largest custodian bank with $16.6 trillion assets under custody once its merger with Mellon Bank goes through.
“We have our own custodial flow data but that doesn’t really reveal anything about the short-term assets involved in the carry trade. In terms of trying to gauge the overall size, it is almost impossible.”
But analysts won’t stop trying. That’s in large part because of the potential for massive market volatility and dislocation from a sudden unwinding of those positions.
Last week, the yen surged, equities tumbled and shockwaves rippled through global financial markets as investors, for no obvious reason, took fright and quit over-extended positions.
Calm appears to have returned this week, but fears linger of an October 1998-style carry trade reversal. Then, the dollar tumbled more than 20 yen in a week after a Russian debt default a couple of months earlier led to the collapse of hedge fund Long Term Capital Management.
Carry That Weight
One difficulty is defining the yen carry trade.
With Japan’s official interest rate at just 0.5%, compared with US and UK rates of 5.25%, the investor base ranges from speculators, hedge funds and proprietary trading desks in the United States and Britain, to Japanese retail investors pouring their savings into foreign bonds via mutual funds.
There’s also an argument to be made that, in effect, Japan’s broad basic balance surplus is a fair measure of the overall short yen position.
That comprises the surplus on Japan’s current account, foreign direct investment and portfolio flows, which is roughly 4.5 % of the country’s entire gross domestic product — or around $215 billion at current exchange rates.
Japan pours that surplus back into foreign stocks, bonds and other securities, effectively shorting the yen in the process.
Stephen Jen, head of global currency strategy at Morgan Stanley in London and who broadly agrees with Watanabe’s estimate, also points to the net exposure of Japanese mutual funds to foreign assets.
Jen says that figure is around 22 trillion yen, just under $190 billion.
“Since these include both foreign equity and bond holdings, the interest rate-sensitive part of these trust fund holdings could be around 10-15 trillion yen or so ...(which) could be the source of Watanabe’s figure,” Jen wrote in a note to clients this week.
“However, I believe that we need to consider if this is a useful definition of the ‘yen carry trades´. Japanese investors are not ‘shorting yen´ to finance these positions. There is no way to distinguish this type of foreign asset holding from, say, New Zealanders’ holdings of US Treasuries.”
It could be argued, for example, that Japan’s stash of almost $900 billion foreign exchange reserves represents a short yen position, albeit longer term than that held by the average yield-hungry hedge fund. But it’s technically a short yen position, nevertheless, that could in theory be unwound at some stage and lead to massive yen-buying.
Still, while nobody can agree on the cash size of the yen carry trade, everyone agrees it’s become extremely stretched.