Despite rising interest rates in Japan, the yen stays weak because of the ongoing appeal of carry trades. Traders see these trades as very profitable in the forex market.
The yen is a popular choice for selling in carry trades. Traders borrow Japan's low-interest currency to invest in higher-yielding dollars. The carry trade becomes more attractive as the yen loses value against the dollar. This strategy has delivered an 18% return over the past year.
Yen faces pressure from carry trades
A showdown with Japanese authorities is coming as they fight against the weak yen. The central bank's policy meeting is just two weeks away, and traders are buzzing with warnings: the yen might soon drop back to a 34-year low of 160.17 due to the popularity of carry trades.
"People are obsessed with carry," said Antony Foster, head of Group-of-10 spot trading at Nomura International Plc. He stated that even if the Bank of Japan raises rates in June, Nomura expects a slight increase with more to follow, and the appeal of carry trades will continue. Therefore, the market is still very hesitant to invest in the yen.
The yen has dropped about 10% against the dollar this year, making it the weakest among the Group of 10 currencies. Investors are moving to higher-yielding alternatives, leaving the yen behind.
Japanese officials are uneasy as the yen's value has nearly halved since 2012 (leading to urgent calls for market intervention). There are signs that these officials influenced the currency markets in late April and early May.
As the yen stays close to 157 per dollar, more downward pressure seems likely. Swap markets expect 27 basis points of rate hikes from the Bank of Japan this year, with a 90% chance of a ten basis point increase in July.
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However, since traders have already expected these hikes, even a hawkish signal from Japan’s central bank next month might not stop the yen from falling further.
According to Mingze Wu, a currency trader stationed at Stonex Financial in Singapore, any forthcoming actions from the Bank of Japan (BOJ) might be insufficient given the market's current trajectory and the strong demand for carry trades that favor shorting the yen.
He notes that the risks for the dollar-yen pair are skewed towards an upward movement, potentially reverting to levels seen before recent BOJ interventions.
As the yen weakens, carry trades are looking more profitable. Investors are watching to see if Bank of Japan Governor Kazuo Ueda will act to stop the yen's drop next month. With only a 28% chance of a small rate hike, carry traders keenly observe other central bank policies that might strengthen the currency.
Jane Foley, head of FX strategy at Rabobank in London, thinks Ueda will carefully choose his words to avoid seeming more dovish than the market expects. Foley suggests that Ueda and the Ministry of Finance (MOF) would instead not intervene further, but this is still unclear. The need for intervention depends on ongoing weak Japanese economic data and strong indicators from US economic reports.
Extended FX trading hours in Korea
South Korea has a well-developed financial market, but its foreign exchange market has limited hours. The Korean won is traded for only 6.5 hours each day. This will change, as the trading hours will soon be extended to 17 hours.
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Should regulators' and the central bank's initiatives proceed as anticipated, the new policies will be implemented by early July. South Korea has diligently prepared for this transition, conducting eight comprehensive tests and engaging 27 institutions.
Participants included companies from the FX sector, especially RFIs. They evaluated how effective and liquid transactions are in the spot and swap markets. The main goal of deregulation is to attract more foreign capital. With the new extended trading hours, the won will be traded until 5 PM in London and noon in New York.
Major reforms started in October 2023 to attract more foreign investments. These new rules remove old barriers, making it easier for overseas companies to enter the market, even if they don't have a local office. In February 2024, it was announced that trading hours for the local FX market would be extended, focusing on the Korean won.