The yen tumbled on Thursday as a strong rally in global equity markets soothed fears that another bout of volatility could lead to further unwinding of carry trades.
The turmoil in financial markets has benefited the Japanese currency over the past week as investors unwound carry trades, in which long positions in riskier high-yielding assets are funded by selling low-yielding currencies such as the yen.
However, Tania Kotsos, strategist at RBC Capital Markets, said the yen’s reversal of fortunes Thursday suggested - tentatively at least - that the unwinding of the carry trade may have begun to run its course.
The yen fell 1.1 per cent to Y117.30 against the dollar and dropped 0.6 per cent to Y153.95 against the euro.
Meanwhile, against higher-yielding currencies, the yen’s fall was more pronounced as it dropped 1.4 per cent to Y226.35 against sterling, fell 1.4 per cent to Y91.05 against the Australian dollar and lost 2.7 per cent to Y80.30 against the New Zealand dollar.
Julian Jessop at Capital Economics said the relative calm in the currency and equity markets over the last few days might suggest that fears about the unwinding of yen carry trades were exaggerated, especially given the continued appetite of Japanese retail investors for overseas assets.
But he said he remained convinced there were still major risks.
He said the more sanguine view was that the majority of identifiable carry trades took the form of a comparatively stable flow of Japanese household savings into foreign bonds, which were relatively insensitive to currency movements given retail investors’ long-term investment horizons.
However, Mr Jessop argued that even if only a small proportion of identifiable carry trades were undertaken by more fickle financial institutions and hedge funds, the risk of a disorderly carry trade unwind would still be large.
“These relatively active investors are likely to have the most influence on price movements from day to day,” said Mr Jessop. “Moreover, the nature of these businesses often means that their exposure is very hard to measure and is almost certainly larger than the flows that can easily be quantified, particularly once leverage is taken into account.”
The low-yielding Swiss franc, investors’ second favourite funding currency, also lost ground, falling 1 per cent to SFr1.2290 against the dollar and dropping 0.5 per cent to SFr1.6125 against the euro.
Meanwhile, interest rate decisions from the European Central Bank and the Bank of England took centre stage.
The ECB, as expected, raised raised eurozone interest by 25 basis points to 3.75 per cent. But it was the post-decision press conference from Jean-Claude Trichet, ECB president, that was the focus of attention as investors picked through his comments for clues as to the future path of eurozone interest rates.
Charles Diebel at Nomura said the fact that Mr Trichet described eurozone interest rates as “moderate” - as opposed to “low” after February’s meeting - suggested that they were close to what the ECB would view as neutral territory.
“Admittedly it does not mean there will be no more [eurozone] rate hikes, but it does suggest the ECB believe its job is almost done,” he said. “Another rate hike is probably only marginally better than a fifty/fifty shot now.”
The euro fell 0.4 per cent to $1.3125 against the dollar and 0.2 per cent to £0.6802 against the pound.
However, sterling eased 0.1 per cent to $1.9295 against the dollar as the Bank of England left UK interest rates unchanged at 5.25 per cent at its monthly policy-setting meeting.
Tom Vosa, head of market economics at National Australia Bank, said as was usual with a “no change” decision, there was no accompanying statement so the market would have to wait for the minutes of the meeting to see how close the voting was.
“We still see scope for one more UK rate increase, which we look for in May,” said Mr Vosa. “However, markets will probably begin to speculate that the end of the tightening cycle could have already been reached, which would put more downward pressure on sterling.
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