Carry trade concerns

Carry trade concerns

Finance ministers and central bankers from the G7 club of rich countries will meet at the end of this week in Essen, a German town. We should pay special attention to one issue they will discuss: the yen.

The Japanese currency has touched a 21-year low on a trade-weighted and inflation-adjusted basis. There is now pressure on Japan to let the yen appreciate.So why should we worry?

A sharp rise in the yen can threaten the so-called yen carry trade, the latest drug in the financial markets. It works like this. Investors borrow cheap money from Japan and then convert it into dollars to invest in markets that give better returns. The size of the carry trade could be anything between $100 billion and $1 trillion. A lot of it has come into India via hedge funds.

A jump in the yen’s value can wreak havoc in the carry trade, especially in highly leveraged hedge funds.

Remember: in 1998, a quick 9% rise in the yen helped bring LTCM to its knees. So watch out what happens after Essen.