Helicopter Ben and the Japanese yen

The Japanese yen is trading in a very strange manner these days. After rising in July and early August, it has since been trading in a very wide and choppy range from roughly 112 to 116.

Nobody understands the yen today. It is being whipsawed between risk aversion and risk seeking, the latter including the yen as the funding currency in carry-trades. In Stage 1, as the sub prime crisis appeared, the yen carry trade lost its allure because risk aversion raised its ugly head. Speculators feared a worse fallout from the U.S. sub prime problem in the high-yielding currency targets of the carry trade (even the euro) and preferred to hold dollars as the safe alternative. Having to buy back yen shorts was a costly experience for many, including Japanese retail investors (who have an astonishingly large position).

Stage 2 is the period just after the Fed cut rates by a dramatic 50 basis points on Sept. 18. Gridlock in credit markets eased and the dollar lost its safe-haven status. The euro hit new record highs. The yen initially returned to its downward trajectory — but after only a few days, it was spiking both up and down.

What’s going on? First, we always have to worry when the dollar is falling against both the European currencies and the yen. It means sentiment is universally dollar negative. The bias means good news is ignored and bad news is exaggerated.

But we also have to wonder what some traders are seeing that we may be missing. Perhaps “new fundamentals” are overriding the old carry trade orthodoxy.