(Bloomberg) -- Unwinding of yen-funded carry trades has further room to run and the Japanese currency may strengthen toward 100 per dollar over time, according to BNY.
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Investors are still too bearish on the yen and short positions will continue to be slashed, said Bob Savage, the firm’s head of markets strategy and insights. An analysis shows the yen is too cheap at its current level of 147 and its fair value over time should be more toward 100, he wrote in a note.
“Expect the pain for yen shorts to remain in play for the weeks, if not months ahead,” Savage wrote. “Further risk reductions are going to follow and August will continue to be a highly volatile month.”
Markets have had a rollercoaster week as traders rushed to dump short-yen wagers amid fears of a US recession and on bets Bank of Japan will hike interest rates further. Now, with epic swings in the past days subsiding, investors are fixating on whether and when the next round of carry strategy unwind may jolt markets again.
The short positions were accumulated over the past years, when traders took advantage of BOJ’s ultra-loose monetary policy to borrow the yen and buy higher-yielding assets elsewhere. The strategy helped to push the currency to the weakest since the 1980s and prompted official intervention to prop it up in July.
Yen-funded trades in a basket of eight emerging market currencies tracked by Bloomberg had delivered investors a total return of just over 17% this year to early July, just before the strategy cracked. The rout saw it erasing almost all its year-to-date gain, according to data compiled by Bloomberg.
Not all Wall Street banks are with BNY. JPMorgan Chase & Co. argues carry unwinding is three quarters complete, while Citigroup Inc. says the strategy is out of the danger zone and the focus should be on China’s yuan for a squeeze.
For Savage, it may be wrong to assume a range of 130-150 per dollar is the BOJ’s new target range for the yen, as economic data between the US and Japan may diverge.
“Given the current environment, the unwinding of yen will take many months to get to fair value again,” he wrote. “That will make the US election and the US business and credit cycles key, along with Japan and its own economic growth.”
(Updates with returns on yen-funded carry trade and chart.)
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