Unwinding of carry trade roadblock for BoJ hikes but not Fed cuts - Goldman

The recent sharp appreciation of the yen, as a consequence of the unwinding of the “yen carry trade”, could be a roadblock to further hikes by the Bank of Japan, said analysts at Goldman Sachs, but not to Federal Reserve cuts.

At 07:00 ET (11:00 GMT), USD/JPY traded 0.3% higher to ¥147.64, with the pair up over 2% over the last week, bouncing back after a sharp drop in July. 

The pair is still down over 6% over the course of the last month.

The big jump in the yen coinciding with a spike in cross-asset volatility has heightened the focus on the “yen carry trade” and the broader financial market implications from further unwinds. 

Limited data availability presents a challenge to confidently assessing “how much is left,” but substantial holdings among longer-term among longer-term investors leave room to run, the bank said, in a note dated Aug. 11.

That said, subsequent unwinds should be broadly slower-moving as, based on futures positioning alone, roughly 90% of speculative shorts appears already undone.

Despite the sharp unwinds, “we believe that coincidental timing of disappointing earnings and a ‘perfect storm’ of JPY-positive factors—including softer macro data, yen supportive intervention, and a surprise BoJ hike—best explains the unusually tight correlation between the sell-offs in USD/JPY and the Nasdaq over the past few weeks, rather than deep leverage from the carry trade,” Goldman said.

Regardless, if Japan sees a renewed sharp tightening in financial conditions, it could complicate the domestic inflation outlook and thus the BoJ’s plan to continue hiking rates—but not the Fed’s readiness to cut. 

Deputy Governor Uchida’s remarks last week demonstrate the BoJ is willing to adjust policy in response to market volatility to avoid rapid and significant yen appreciation that would jeopardize progress towards their inflation goal.

Any financial market instability looks more likely to be driven by material risk of a U.S. recession or stress in the system rather than deep leverage in the yen carry trade, the bank said.

Moreover, in such a scenario, the scope for rapid Fed cuts—and fear of carry trade unwinds is not a reason for the Fed to hesitate on cuts—should be supportive for financial stability rather than further fuel concerns, despite the consequences of a stronger yen (though this could be a reason for the BoJ to pause further hikes).

 

Source: Investing.com