Global market action in August was downright ugly. Stock markets plunged and many commodity markets collapsed as money managers squared any and all positions amid the liquidity crunch sparked by the problems in the U.S. sub-prime mortgage market.
The Japanese yen had a starring role in this drama because of its status as a “funding currency” for carry trades.
Figure 1 shows the dollar/yen (USD/JPY) plummeted 12 full points this summer as the yen gained strength against the dollar, falling from above 124.00 in mid-June to just a smidge under 112.00 in mid-August. The yen also surged notably vs. the euro (EUR), the Australian dollar (AUD), and the New Zealand dollar (NZD) — all popular legs of the carry trade.
What’s behind the yen’s big move? In large part, a massive unwinding of carry trades, which has left some currency market players wondering if that perennially popular strategy has finally run its course.
“There has been plenty of fear to go around in the past few weeks, and there’s no doubt that people only buy the yen when they’re frightened,” says Sean Callow, senior currency strategist at Westpac Institutional Bank. “Why would you buy yen on fundamentals? It’s dismally low yielding and Japan’s equities have considerably underperformed global and regional benchmarks this year. Japan’s recent economic data has been disappointing, its headline CPI numbers are still reporting deflation, and its politics have taken a turn for the worse.”
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