What Does Yen Carry Trade Means And What Kind Of Effect It Can Have On Your Forex Trading Performance?
Yen carry trade is a form of currency carry trade using the Japanese yen. Carry trade is an investment strategy in which the trader borrows (buys) a currency with a low interest rate and lends (sells) a currency with a high interest rate. In this way they can earn profits on the disparity between the interest rates.
This type of investment is popular with banks, central banks and other large lending institutions, especially at times when the the worldwide foreign exchange 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 frequently involved in carry trade. This is because over the past years it has continuously been a primary 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%.
Actually you would not expect carry trade to be profitable as the currency rates would adjust to reflect the difference in interest rates and this would balance out the possible profits. Still, in practice there is a profit potential because carry trades have the impact of depreciating the borrowed currency. So yen carry trade maintains the yen artificially weakened.
Of course there is a risk that the tide will turn but due to the level of control exerted by the Bank of Japan, worldwide confidence is typically quite buoyant. However, in the case of a major 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 substantial change in foreign exchange values such that the yen rises in value against the lent currencies, it is possible for the investors to lose money when it comes to reversing the scheme. Since there is a massive amount of money invested in yen carry trade it can have a powerful destabilizing impact on the forex markets if investors suddenly turn away from this kind of investment.
This outcome is known as the unwinding of yen carry trade. It happens when investors become averse to risk which is likely to happen when the yen is moving up against the lent currencies. This could have a powerful effect on the value 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 money markets. It is not something that a home based currency trader would typically 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 effect on yen prices. Forex signals could be a useful trading tool to foretell, when the price 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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