Yen-funded carry trade lifts sterling and Aussie dollar

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The yen continued its recent slide this week as soft Japanese economic data gave carry trade investors every incentive to keep borrowing the low-yielding currency and seek higher returns elsewhere.

Perhaps unsurprisingly, the week’s best performing major currencies were the high-yielding Australian and New Zealand dollars and sterling, the main beneficiaries of the global carry trade.

Over the week, the yen fell 1.1 per cent to a year-to-date low of Y89.78 against the Aussie dollar, 3.5 per cent to Y76.68 against the kiwi and 0.8 per cent to Y223.05 against sterling, its lowest level since October 1998.

“The market has probably got sterling’s all-time high in its sights now,” said Neil Mellor, currencies strategist at Bank of New York, referring to the Y239.80 reached in August 1998.

Strategists spent much of the week cutting back their expectations for interest rate rises in Japan in the wake of last week’s exceptionally soft inflation data. Amid soft industrial production, construction orders and housing starts numbers this week, analysts now believe Japanese rates will stay at their current miserly 0.25 per cent until the end of the calendar year, and maybe even the fiscal year.

This is encouraging everyone from hedge funds to Japanese retail investors to short the yen.

“The yen has been persistently weak as the market pushed back Bank of Japan tightening expectations and as global risk aversion has declined, resulting in an increase in yen-funded carry trades,” said Mansoor Mohi-uddin, UBS chief FX strategist.

The yen’s losses against other major currencies were more modest, as it slipped 0.4 per cent to Y150.26 against the euro, hitting a fresh all-time low of Y150.78 on Thursday, and held steady at Y117.23 against the US dollar. However, the Japanese currency still hit a 21-year low in real effective terms.

There were increasing signs that the Swiss franc, backed by interest rates of just 1.5 per cent, was suffering the same fate as the yen.

The Swissie fell 0.2 per cent to SFr1.5795 against the euro Friday, even as Switzerland’s manufacturing purchasing managers’ index rose to a historic high, on the day the equivalent eurozone measure disappointed.

Sterling’s gains were supported by strong retail sales and housing data, strengthening the view that UK rates will head higher, probably in November. The pound rose 0.8 per cent to $1.9031 against the dollar and 0.4 per cent to £0.6732 to the euro.

The renminbi enjoyed its strongest week since its 2.1 per cent revaluation in July 2005, rising 0.29 per cent to Rmb7.9532 to the dollar, taking its gains since the abandonment of a decade-old dollar peg to 1.9 per cent.

Beijing is likely to face further pressure to free up its currency at G7 and International Monetary Fund meetings due to be held in Singapore later this month.

Some saw this as a ray of hope for the yen, in the belief that a stronger renminbi would lift all Asian currencies.

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