Yen surges as carry trade unwinds


A dramatic surge in the Japanese yen over recent days has cut off a key source of liquidity for the global asset boom, setting off a panic flight from emerging markets for the first time since the latest turmoil began.

Bourses tumbled across Asia where central banks intervened in several countries to stabilize their currencies, with contagion spreading to South Africa, Eastern Europe and Latin America. Stock markets were down by 6.44% in Indonesia, 4.08% in the Philippines, 3.4% in Singapore, 3.3% in Taiwan and 2.9% in Hong Kong. New Zealand’s bourse plummeted to its lowest level in almost a year, while Brazil was off more than 2% in early trading. Interest spreads on Argentine, Venezuelan, and Ecuadoran bonds have all jumped by more than 40 basis points over the last two days. The South African rand hit a five-month low of 7.40 against the dollar yesterday.

Hans Redeker, currency chief at BNP Paribas, said the yen surge came as funds scrambled to unwind “carry trade” positions and had now become a critical factor in the worldwide financial crisis. Japanese investors and foreign funds borrowing in yen at near zero interest rates have accumulated roughly $1,200 billion (£603 billion) of unhedged positions outside the country, according to BNP Paribas, much of it in high-yielding markets in East Asia or places as far away Iceland, New Zealand and Brazil. The yen flows have been a key prop for world asset markets over the last two years, along with the petro-dollar surpluses of the oil exporters and the growing reserve war chests of China, Russia, and other rising powers.

A smaller Swiss franc carry trade has played a similar role in Eastern Europe, funding a regional property bubble. More than 80% of all mortgages in Hungary over the last year have been in francs. “We’re now seeing a vicious cycle where all this goes into reverse. The impact could be enormous,” said Redeker. The wild card is the behavior of hedge funds and speculators who have borrowed an estimated $200 billion in yen - often with high leverage through derivative contracts - in order to play the carry trade. All this money has to be repaid in rising yen, perhaps in a brutal “short squeeze”. “The banks have stopped lending to hedge funds so they are having to raise money where they can, and that means selling their most liquid assets into a falling market,” Redeker said.

The scale of forced portfolio liquidation will become clearer after last night’s expiry of the Q3 deadline for hedge fund redemptions, which must be submitted 45 days in advance. If too many investors rush for the exit at the same time, this August 15 cut-off could prove to be the trigger for another bout of global turmoil. The yen has already snapped back like stretched elastic from an extreme of ¥169 against the euro in late July to ¥158, mostly in the last five trading days. Redeker said it still remains “wildly out of whack” with fundamentals after years of carry trade outflows. The bank said the purchasing power parity was nearer 120 yen. The scale of the move recalls the violent yen rebound in 1998, a key factor in the chain reaction that led to a global banking crisis that autumn.

Carsten Valgreen, global strategist at Danske Bank, said emerging markets had been remarkably resilient over the last two weeks but were now an obvious target if the sell-off spreads further. “As the world’s easy liquidity show ends, we’re going to find out who did foolish things with that liquidity. In parts of Eastern Europe, we’ve seen a monster bubble,” he said. “The current account deficit is 25% of GDP in Latvia and Bulgaria, and 18% in Romania. These deficits have been widening faster and faster, and ever more is going into housing and spending booms,” he said.

Both Fitch Ratings and Standard & Poor’s have warned over recent months that credit growth has mushroomed out of control across much of the former Communist bloc, replicating patterns that have led to financial crisis in the past. An unpublished IMF paper said excesses resembled those of the East Asia bubble in 1997. Phillip Poole, an economist at HSBC, said the rising stars of Asia, Africa and Latin America may ultimately hold up better than America or Europe. “Developing countries now have much bigger reserves than they used to have, and more responsible fiscal and monetary policies. They’re not the ones with the big deficits any longer,” he said. (

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