Here's why everyone is talking about Japanese Yen and Carry Trade

Japanese Yen, a favourite for carry trade, has appreciated by 10 per cent in the last three weeks; thus, prompting fears of large scale unwinding and its ripple effects on global markets

Japanese Yen Carry Trade: Japan's yen hit mid-January highs around 145.28 in Monday's intraday deals, thus extending its recent appreciation against the US dollar. Japan's currency has appreciated by 10 per cent against the dollar in just over 3 weeks, partly driven by the Bank of Japan's (BoJ's) 15-basis points rate hike to 0.25 per cent last week.

Earlier ,on March 19, the Japanese Central Bank first hiked interest rates after 17 years to 0.10 per cent. That apart, last week, BoJ also said it would halve its monthly bond purchases over the next couple of years in its bid to strengthen the currency and economic growth. The move, however, is expected to have an adverse impact on carry trade. 

Japanese yen: A currency safe haven

The Japanese Yen has been considered as safe-haven and a favourite among carry-funding options by global investors given the low cost of borrowing. 

According to reports, analysts at Barclays believe that the Japanese currency was the most overbought among G10 majors and therefore "the bar for yet more outperformance in the near term appears high".

The fear of unwinding of Yen-based carry forward trade, however, has impacted global market sentiment. Markets across Asia were in a deep sea of red, with Japan's Nikkei tumbling almost 13 per cent on Monday. Kospi and Taiwan slumped over 8 per cent each.

Why are the markets fretting about Japan's currency appreciation and the likely ripple effect on the carry forward trade? Here's all you need to know:

What is a carry trade?

Carry trade is a trading strategy that involves borrowing money at a low-interest cost and investing the same in other assets that provide higher returns.

Carry trade is popular among forex trades wherein an investor borrows from a country with low interest rates and a weaker currency, and reinvests the money in another country for higher returns.

Due to the BoJ's ultra-loose policy for 17 long years, and a weak yen, global investors preferred Japan's Yen for carry trade.

Why are investors now unwinding the Yen carry trade?

The Japanese Yen has appreciated by 10 per cent over the last 3 weeks from levels of 161 on July 11 to 145 now. As the Yen appreciated against the US dollar, investors had to rush and unwind their carry trade in order to cut losses. This is said to be one of the reasons for the fall in the US equity market.

Does India need to worry about Yen appreciation and carry trade impact?

According to NSDL, Japanese foreign portfolio investors hold equities worth Rs 2.05 trillion. A stronger Yen would prompt some selling by these sets of investors.