Yen carry trade is a form of currency carry trade using the Japanese yen. Carry trade is an investment strategy in which an investor borrows (buys) a currency with a low interest rate and lends (sells) a currency with a high interest rate. Applying this method they may earn money on the disparity between the interest rates.
This type of investment is popular with banks, governments and hedge funds, particularly at times when the the worldwide currency markets are relatively solid and the global stock markets are broadly bullish. In other words, it can be a successful investment strategy at times of world economic stability and growth.
The Japanese yen is the currency most commonly taking part in carry trade. This is because over the past years it has continuously been a major currency with the lowest interest rate. The Bank of Japan, which manages Japanese interest rates, has set them at a a very low level since the late 1980s. Often this is under 0.5%.
Theoretically you would not count on carry trade to be lucrative as the currency values would correct to reflect the difference in interest rates and this would balance out the possible profits. Still, in practice there is a profit opportunity as carry trades have the impact of weakening the borrowed currency. So yen carry trade maintains the yen artificially weakened.
Certainly there is a risk that the tide will turn but due to the level of control exerted by the Bank of Japan, international confidence is typically quite buoyant. On the contrary, in the case of a significant financial crisis in the USA and the other main economic powers the yield of carry trade is bound to fall.
Certainly where there is a big change in foreign exchange values such that the yen goes up in value against the lent currencies, it is possible for the investors to lose money when it comes to reversing the investment. Since there is a massive amount of capital involved in yen carry trade it can have a powerful destabilizing effect on the financial markets if investors suddenly turn away from this form of investment.
This outcome is known as the unwinding of yen carry trade. It occurs when investors become averse to risk which would probably happen when the yen is moving up against the lent currencies. This can have a powerful effect on the price of yen currency pairs. As we saw, yen carry trade weakens the yen so the effect of the unwinding will be to strengthen the yen side of the pair even further.
Yen carry trade is for the large players in the international financial markets. It is not something that an independent currency trader would usually expect to get engaged in directly. However, any forex trader involved in a yen pair needs to be aware of yen carry trade and its impact on yen prices. Forex signals could be a helpful trading tool to foretell, when the tide turns for yen crosses. There are plenty of forex signal services covering yen pairs online. However, make sure that you trade only reliable forex signals!
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