Traders Resume Yen-Dollar Carry Trade As Bank of Japan Pledges No Rate Hikes During Market Volatility

Traders rekindled their bullish bets on the yen-dollar carry trade Wednesday after dovish signals from the Bank of Japan prompted a rethink of recent market movements.

The Japanese yen, as tracked by the Invesco CurrencyShares Japanese Yen Trust FXY, tumbled over 1.9% past 147 per dollar by 10:00 a.m. in New York as Bank of Japan (BOJ) Deputy Governor Shinichi Uchida pledged not to hike interest rates if markets are volatile.

“As we’re seeing sharp volatility in domestic and overseas financial markets, it’s necessary to maintain current levels of monetary easing for the time being,” Uchida said in a meeting with business leaders in Japan.

“Personally, I see more factors popping up that require us being cautious about raising interest rates,” Uchida added in a post-meeting news conference.

Also Read: Mortgage Rates Fall To 15-Month Lows, Boost Homebuyer Demand As Federal Reserve Hints At Rate Cuts

Is The Yen-Dollar Carry Trade Strategy Back On Track?

“Today's announcement from BOJ about a halt on rate increases suggests the damage from the unwinding of the carry trade still needs to play out, as it’s possible many hedge funds, etc. still remain offsides,” said John Lynch, chief investment officer for Comerica Wealth Management.

“This dampened fears that the BOJ would rush to raise rates further, as it was last week's bigger-than-expected hike which was seen as one of the triggers for the stock market rout. The speech has helped to soften the yen and give back some of last month's outsized gains. That should take some pressure off those still exposed to the yen carry-trade, of which there are still significant numbers,” said David Morrison, senior market analyst at Tradenation.

The yen-dollar carry trade has become an increasingly popular trading strategy since the Federal Reserve began raising rates in March 2022, as traders bet on the Bank of Japan maintaining ultra-low interest rates, allowing them to leverage cheap yen borrowing to invest in higher-yielding U.S. dollar assets like Treasuries.

Interest rate differentials between the Federal Reserve and the Bank of Japan drove the dollar up by 40% against the yen between March 2022 and July 2023.

The yen-dollar carry trade abruptly imploded last week after the Bank of Japan raised rates while the Federal Reserve pledged to start cutting interest rates, triggering a sharp reversal in short-term yield differentials between the two regions.

A lower-than-expected U.S. jobs report for July, released last Friday, further accelerated the unwinding of the yen-dollar carry trade as investors increased their bets on Fed rate cuts amid rising recession risks.

However, a stronger-than-expected U.S. services sector report released on Monday prompted a reassessment of recession fears, leading traders to revise again their expectations on interest rates.

After dropping to a low of 141.60 on Monday, the dollar-yen exchange rate rallied 3.8% by Wednesday morning.

Yen-Dollar Carry Trade Unwind Pauses Amid Easing US Recession Concerns, Dovish BOJ Comments

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