The U.S. dollar experienced a period of extremely low volatility last week – let’s just blame it on tax season. Surprisingly, it was the Japanese Yen that moved the most in the global markets, and the mover behind this was “Mrs. Watanabe,” the common term for Japanese housewives.
Let me explain this trend. Japan’s new fiscal year started on April 1, when the consumption tax also went up to 8% from 5%. This is in synch with a series of policies pursued under Prime Minister Shinzo Abe, with the ultimate goal of turning the economy around from a deflationary stage to an inflationary one.
While some feared the consumption tax hike would put a brake to Japan’s economic recovery, BOJ Governor Kuroda affirmed his upbeat view of the economy, assuring that Japan was only half-way toward meeting its 2% inflation target which he believes will be achieved within the next 12 months. Japan’s core consumer prices rose 1.3% in February, the ninth consecutive month of increases.
With higher inflation, a weakening currency and a rise in consumption tax, Mrs. Watanabe is watching her savings depreciate in value and feels she cannot afford to keep her money in cash anymore. Consequently, she has been opening up foreign currency accounts, such as the NZD, MXN and the AUD, that offer higher interest rates. This has led to the weakening JPY and strengthening of these currencies. Statistics show that individual investors in Japan hold about 30% more foreign currency accounts than a year ago.
This phenomenon of selling the low yielding currency and buying of the higher yielding currency is well-known in the professional world as ‘carry trades.’ These trades tend to happen in times when the FX market has low volatility, as investors seek higher returns and take larger risks. While potentially profitable, the trend can also reverse very quickly, which could potentially lead to a sharp currency and income loss.
My View: Carry trades are not for everybody. They are certainly more suited to those who are well trained and comfortable with the FX market. Be sure to speak to one of our FX specialists for more advice.
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