Foreign Currency: The yen is sending a buy signal

Posted January 23, 2008

"Why would the yen promise to rise this year? Three reasons: global interest rates, stock market risks and currency volatility." — Sean Hyman

Sean Hyman, currency director at The Sovereign Society, revealed an interesting trend to his A-Letter readers this week. According to Sean, despite the recent rollercoaster ride of the Tokyo markets, the Japanese Yen is still going to rise in 2008. And that movement could make you a pretty (American) penny if you know where to look. You can find the article here or read on for more.

by Sean Hyman, The Sovereign Society

Baltimore – (TFN): Most of the time, currencies move due to fundamental macro-economic reasons, but this year's rise in the Japanese yen has very little to do with Japan's fundamentals. In fact, Japan's economic fundamentals aren't that impressive right now.

So why would the yen promise to rise this year? Three reasons: global interest rates, stock market risks and currency volatility.

For years, Japan had extremely low interest rates - literally 0% to 0.5%. Japan maintained these low interest rates because they wanted the Japanese economy to recover. So Japan kept rates low to encourage the Japanese corporations to expand.

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Japan has also been stuck in a deflationary economy for years. So the Japanese lowered rates literally as far down as they could go.

Foreign Currency: Yen a bullseye for investors

This "free" to "almost free" money made the yen an easy target for investors. They borrowed the yen to fund trades in almost anything they felt would earn more.

It was a pretty safe bet to put this borrowed money in everything from the Dow Jones Industrial Average to high-yielding currencies like the euro, British pound, New Zealand and Australian dollars, etc.

This "new-found" money fueled a stock market rally along with a rally in high-yielding currencies. It was a "no brainer" for years. Prices went up in an orderly fashion. Traders could sleep well while they pocketed the difference between what the stock index or currency produced and their (almost non-existent) borrowing rate.

It was worth the risk to earn the difference between what you paid out in yen loans and what you made on your investment in the higher yielding currency.

So what disrupted such a perfect investment strategy? In a word: Volatility. This strategy only works if high-yielding assets are rising in low volatility. Suddenly, the markets were not only volatile but prices started dropping. Prices started to sink and investors started "shaking in their boots." These investors suddenly had to buy yen back to fund their trades. This is what's known as the "carry-trade unwind." Read on to learn how you could profit from the carry-trade unwind.

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