Investing.com – The recent sharp rise in the yen, as a result of the unraveling of the “yen carry trade,” may be a barrier to further increases by the Bank of Japan, but not a barrier to Federal Reserve cuts, Goldman Sachs analysts said.
At 07:00 ET (11:00 GMT), the pair was trading 0.3% higher at 147.64 yen, having gained more than 2% over the past week, rebounding after a sharp decline in July.
The pair is still down more than 6% over the past month.
The sharp rise in the yen’s value, coupled with a sharp rise in cross-asset volatility, has heightened focus on the “yen trade” and the broader implications for financial markets of further declines.
Limited data availability presents a challenge to confidently assessing “the amount remaining,” but large holdings among longer-term investors leave room to run, the bank said in a note dated Aug. 11.
However, subsequent liquidations are expected to be broadly slower, with around 90% of speculative short selling appearing to have already been reversed, based on futures positions alone.
Despite the sharp declines, “we believe the simultaneous timing of disappointing earnings and a perfect storm of yen-positive factors — including weaker economic data, yen-supportive intervention, and a surprise rate hike by the Bank of Japan — better explains the unusually tight correlation between the USD/JPY sell-off and the Nasdaq over the past few weeks, rather than deep leverage from carry trades,” Goldman said.
However, if Japan sees a renewed sharp tightening in financial conditions, it could complicate the outlook for domestic inflation and thus the Bank of Japan’s plan to continue raising interest rates – but not the Fed’s willingness to cut.
Comments by Bank of Japan Deputy Governor Uchida last week suggest the BOJ is prepared to adjust policy in response to market volatility to avoid a rapid and large appreciation of the yen that would jeopardize progress toward its inflation target.
The bank said any volatility in financial markets appeared more likely to stem from physical risks from a U.S. recession or systemic stress than from deep leverage in the yen carry trade.
Moreover, in such a scenario, the scope of the Fed’s rapid cuts – and fear of a carry trade downturn is not a sufficient reason for the Fed to hesitate to cut – should be supportive of financial stability rather than fueling further concerns, despite the consequences of a stronger yen (though this could be a reason for the BOJ to hold off on further increases).