Yen Carry Trade’s Appeal Shows Japan Is Losing Mojo

Jan. 18 (Bloomberg) -- Currency strategists are more in sync than any time since the depths of the financial crisis, increasing incentives to bet against the yen after the carry trade lost money in December for the first time in 10 months.

Forecasts for the euro, yen and Swiss franc from 61 Bloomberg survey contributors are within 9 cents of the mean on average, down from 11 cents a year ago. They haven’t been so unified since Lehman Brothers Holdings Inc.’s 2008 bankruptcy. The predictions’ so-called standard deviation fell 16 percent last quarter, the biggest drop in at least two years, after jumping 48 percent in the three months after Lehman’s demise.

The growing consensus signals that foreign-exchange swings will decline, luring investors to sell currencies from countries with lower interest rates to buy higher-yielding ones. That may weaken the yen and franc, and rein in the resurgent dollar. Japan’s currency, which fell 6.6 percent since its 14-year high of 84.83 per dollar on Nov. 27, may be the biggest loser as Prime Minister Yukio Hatoyama fights deflation and a recession.

Declining volatility and the rising U.S. currency means “people are thinking about alternatives to the dollar as a funding vehicle, and the yen is the obvious candidate,” said Richard Franulovich, a strategist in New York at Westpac Banking Corp., Australia’s second biggest bank. “Not only do they already have low rates, the authorities are talking about a new quantitative-easing program. There’s a big fiscal expansion playing out under the new government, and the currency had a big rally last year.”

Carry Returns

Westpac was one of 2009’s 10 best yen forecasters, data compiled by Bloomberg show. Selling yen to buy Australian and New Zealand dollars, Norwegian krone and Brazilian reais returned 33 percent last year. Using the dollar earned 31 percent.

Funding the carry trade with the greenback lost money in December for the first time since February as the U.S. currency gained 4.8 percent against the euro amid growing confidence in the U.S. economy and expectations that the Federal Reserve will raise borrowing costs by June. Futures trading on Dec. 31 suggested a 62 percent chance the Fed would increase its benchmark to at least 0.5 percent by mid-year from a range of zero to 0.25 percent, up from 30 percent in November, Bloomberg data show. The Bank of Japan’s target rate is 0.1 percent.

Buying and selling high- and low-yielding currencies to take maximum advantage of global rate moves gained 19 percent from February to November, the carry trade’s best nine months since 2003, a Royal Bank of Scotland Plc index shows. The index fell 0.9 percent in December.

‘U-Turn’

“The U-turn in the dollar led to a reverse carry trade in December where people were selling the commodity currencies,” said Theodore Chen, a quantitative analyst at RBS in London who oversees the index.

Rapid exchange-rates swings tend to erode the carry trade’s profits. Greater certainty about the direction of currencies this year may help damp volatility, reducing the chances of a repeat of December’s turnabout.

Risk returns have shifted in favor of the yen since late last year, as measured by the Sharpe ratio, a gauge of gains that takes volatility into account. In the year ending Nov. 30, selling the dollar versus the currencies of Australia, New Zealand, Norway and Brazil had a risk-premium ratio of 2.31, compared with 1.24 for the yen. Since then, the ratios are 2.71 for the yen and less than zero for the dollar.

‘Faster Pace’

“Yen volatility can come down at a faster pace than dollar or Swiss crosses, making it more useful as a funding source going forward,” said Paul Mackel, the director of currency strategy at HSBC Holdings Plc in London. “There’s going to be a reflating of the yen carry trade.”

Analyst forecasts on the yen against the dollar varied from the mean by 9 cents at the end of last week, compared with 10 cents at the end of 2008, Bloomberg data show. Dollar forecasts against the euro also had a standard deviation of 9 cents last week, down from 12 cents. For the Swiss franc, the figure fell to 8 cents, from 11 cents. The Swiss National Bank’s key rate is 0.25 percent.

JPMorgan Chase & Co.’s index of volatility in the Group of Seven currencies has fallen 12 percent this year, the most since the two weeks beginning March 27, 2009.

Yen Forecasts

Carry-trade returns will benefit this year from the yen weakening 7.2 percent to 98 per dollar from 90.93 today, according to the median forecasts in Bloomberg surveys. The franc is predicted to weaken 4.8 percent to 1.08 per dollar.

The dollar has the least bearish outlook -- a 1 percent decline to $1.45 per euro, from $1.4362. Bets on gains for the IntercontinentalExchange Inc.’s Dollar Index -- a gauge against the euro, yen, pound, Canadian dollar, franc and Swedish krona - - outnumber bearish wagers by 6 to 1, the most since March.

Even assuming stable currencies, buying 12-month bills in reais, kronor, Australian and New Zealand dollars with Japanese yen will return 5.2 percent more than holding equivalent- maturity Japanese bills, compared with 5 percent for the same trade with the dollars.

‘Disastrous Strategy’

Selling the yen against that basket of currencies lost investors 34 percent in 2008 as volatility on the Japanese currency against the dollar rose to 26 percent in December, the most since at least 1991. Using the dollar as the funding currency lost 17 percent.

“The carry trade works under conditions of low volatility, which is why it was the most disastrous strategy in 2008,” said Stuart Thomson, a Glasgow-based fund manager at Ignis Asset Management, which oversees $100 billion.

Yen volatility is likely to decline as the Bank of Japan keeps its benchmark rate on hold through next year as it battles deflation, according to median forecast of 28 economists.

Japanese consumer prices are forecast to fall 1.3 percent in 2009, by the same amount in 2010 and a further 0.3 percent in 2011, according to median economist forecasts in Bloomberg surveys. The country’s economy will expand 1.4 percent in 2010, after contracting 5.3 percent last year, the estimates show.

In Switzerland, inflation will hold at 0.6 percent through 2010, the Bloomberg survey shows. In the U.S., there is an 80 percent chance the Fed will raise its key rate to at least 0.5 percent by the end of the year, futures trading shows. The U.S. economy will grow 2.7 percent this year, according to the median of 57 economists’ forecasts compiled by Bloomberg.

Brazil, Norway

In Brazil, the central bank will increase its rate to 10.5 percent from 8.75 percent as growth accelerates to 4.75 percent from 0.2 percent in 2009, according to Bloomberg surveys. Norway will lift its rate to 3 percent from 1.75 percent, and Australia’s will rise to 5 percent from 3.75, the polls show.

Japanese Finance Minister Naoto Kan said Jan. 14 there are “still various policy measures that can be taken,” signaling the Bank of Japan will take further action to aid the economy. Morgan Stanley, Goldman Sachs Group Inc. and Pacific Investment Management Co. analysts said this month the central bank may increase the amount of money it adds into the economy through purchases of government bonds to combat deflation.

The Democratic Party of Japan’s popularity has slid since it came to power for the first time four months ago promising to end 20 years of economic stagnation. Prime Minister Hatoyama’s approval rating was at 56 percent this month, compared with 75 percent when he took office, the Yomiuri newspaper said Jan. 11, without giving a margin of error.

Japanese Exporters

A weaker yen will benefit Japanese exporters, including Toyota Motor Corp., the world’s largest manufacturer of automobiles, and Sony Corp., which is forecasting a second annual loss. Japan exports more than it imports, giving it a current-account surplus every year since at least 1986, when Bloomberg began collecting the data. Exports accounted for 14 percent of Japanese gross domestic product in the third quarter, compared with 11 percent in the U.S.

The policies of the government and central bank are “a signal to the market, saying ‘Hey, use the yen as a carry trade because we’ll be back into the market printing lots of yen to push the currency lower,” said Axel Merk, president of Merk Investments LLC in Palo Alto, California, and manager of the $477 million Merk Hard Currency Fund.

Some analysts predict the yen will rise against the dollar as the U.S. currency suffers more from a global slowdown. Eisuke Sakakibara, formerly Japan’s top currency official, said the global recovery may slow in the second quarter, pushing Japan into a double-dip recession and weakening the dollar to 85 yen from 90.85 today.

“Should the U.S. experience a relatively weak rebound from spring to summer there’s a high possibility the dollar will drop,” said Sakakibara in a Jan. 15 interview in Tokyo.