Carry trade led to record levels

Looking back, the carry trade has been a dominant driver of yen action in recent years. Euro/yen, considered by many as the best barometer of the yen carry trade, surged to a record high (since the euro’s inception in 1999) at 169.10 in July of this year (Figure 2). Dollar/yen hit its highest level since December 2002 in June (Figure 3).

Regarding the financial turmoil surrounding the credit crunch in the U.S. mortgage market, Michael Woolfolk, senior currency strategist at the Bank of New York Mellon says, “We had a classic panic. It was a liquidity crash.”

Central banks around the globe responded by flooding the markets with liquidity; the U.S. Federal Reserve slashed its discount rate 0.50 basis points to 5.75 percent.

“Carry trades were sold,” Woolfolk says. “People were essentially taking profits in the carry trade and, given the market’s rise in risk aversion and capital flight, it caused a further unwinding of the carry trade.”