There are few things that traders like better than blowing a raspberry at the Group of Seven industrialised leaders. Monday was a case in point.
On Saturday, G7 financial leaders solemnly opined that “Japan’s recovery is on track” – and suggested that “the implications of these developments will be recognised by market participants and …incorporated in their assessments of risks”. Translated from policy speak, this means the G7 wants traders to stop betting on a never-ending yen decline.
But when markets opened on Monday, the Japanese currency duly weakened further, touching Y122.09 to the dollar and Y159.00 to the euro. On a trade-weighted basis, that leaves it at 21-year lows.
This suggests that investors do not believe the G7 is ready to turn its woolly rhetoric into tangible intervention. Right now, that seems a fair bet. After all, the yen has left global policymakers trapped between a rock and a hard place. Politicians in regions such as Europe want the yen to rally, to help their manufacturers; but at the same time, regulators know that if a sharp rally does occur, this could risk triggering financial shockwaves. This is because a key reason behind recent yen weakness is that the carry trade – or the practice of borrowing in low-yielding currencies to invest in higher-return assets – has proliferated in the past three months.
This has swelled global liquidity, flattering asset markets around the world. But if the yen suddenly strengthens – say, due to G7 intervention – carry trades might be unwound, which might even spark a wave of global risk aversion.
Given this, it is not surprising that G7 policymakers prefer to pray for a miracle – namely that the yen will soon stealthily appreciate of its own accord, thus prompting an “orderly” unwind of carry trades.
But that seems a brave hope, given the apparent size of these trades. After all, the lower the yen falls, the greater the risk of a financial whiplash if – or when – it changes course. Investors in almost any asset class, from Australian stocks to Zambian bonds, should be keeping a close watch on events in Japan.
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