Goldman Sachs strategists believe the recent pullback in the carry trade involving the Japanese yen (JPY) still has a long way to go, despite the big moves we have already seen.
The sharp selloff that began late last week has drawn significant attention to how deep the yen carry trade has become and how long it could last. Strategists said the limited data available makes it difficult to predict, though there are some key indicators to watch.
While the latest data from the Commodity Futures Trading Commission suggests that net short positions among non-commercial investors have fallen from about $15 billion to just $1 billion, that doesn’t reflect the full picture, according to a Goldman Sachs note released Friday.
“This alone suggests that nearly 90% of carry trade liquidations have been executed,” the strategists said.
“While it is difficult to be completely confident in any estimate, we believe the true figure is likely to be lower, leaving more room for movement given the large holdings in the ‘firmer’ parts of the investor space and positions taken outside of futures markets.”
Goldman Sachs notes that total foreign equity holdings among Japanese equity mutual funds, public pension funds and other large investors have risen to about 300 trillion yen as of the first quarter of 2024, from 135 trillion yen before the Bank of Japan began its aggressive monetary easing policies.
Even if we assume that only half of these investments are exposed to currency fluctuations, nearly $1 trillion is at risk of significant losses if the yen continues to rise, which could lead to further repatriation flows and fuel both equity sell-offs and rapid appreciation of the yen.
“However, any related flows are likely to be slower on average compared to the rapid turnaround we have already seen in the speculative community,” the strategists continued.
“Moreover, we are skeptical that the yen has been used extensively as an explicit fund for long investments elsewhere, particularly in the case of U.S. technology stocks,” they added.
Instead, strategists believe the recent correlation between USD/JPY sell-offs and Nasdaq declines is more likely the result of a “perfect storm” of yen-supportive factors than deep leverage from carry trades.
However, if Japan sees another sharp tightening in financial conditions, it could disrupt the domestic inflation trajectory and potentially derail the Bank of Japan’s ongoing plans to raise interest rates, as Deputy BOJ Governor Uchida noted. That’s a key reason why Goldman Sachs believes a rapid and significant strengthening of the yen is unlikely unless there is a significant risk of a U.S. recession.
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