02-04-2007: Yen-RM carry trade very much in play

The yen carry trade has played a significant part in causing the rise and volatility of Bursa Malaysia for the past few months, and will continue to do so as long as the wide interest rate differentials between the United States and Japan stays.

MIMB Investment Bank Bhd’s technical analysis manager Lee Cheng Hooi said there has been a strong correlation between the yen/ringgit exchange rate and the KL Composite Index (KLCI).

He said so long as there were profits to be made due to the wide interest rate differentials, there would be still positive flows in the yen-carry trades and this practice would continue.

Yen-carry trades are any investments in all asset classes, which are financed by yen-denominated loans, bearing very low Japanese interest rates.

The danger is when such carry trades are pulled back such as February’s equity sell-off in Asia as investors panicked partly due to Japan raising its interest from 0.25% to 0.50%.

Lee said factors, which will cause the unwinding of such positions, were the narrowing of the yen and the US dollar interest rates or regulatory intervention similar to those imposed by Thailand in mid-December 2006.

“I don’t think all those trades were unwound yet in Malaysia or the rest of the world,” Lee said.

MIMB research head Pong Teng Siew said the size of the outflows of yen from Japan to the rest of the world could be as large as US$9 billion (RM31.4billion) to US$10 billion per month.

“Nobody really knows how large the yen-carry trades are in Malaysia. But we believe these trades are working in the background and dominating the current volatility of the stock market.

“In the past, hedge funds used to be involved in the yen-carry trades. However, this profitable practice has spread to some of the conventional international equity funds.”

Pong added that the yen-carry trades strongly fuelled the Malaysian equity market rise since October 2006. Earlier, these practices started globally as early as the first quarter of 2004.

He said the yen hit a high of 101.60 yen/US$ in that year and the US Federal Reserve increased its target interest rate on May 2004 from 1.00% to 1.25%, the first hike of the eventual 17 consecutive hikes.

“The continual divergence of the yen and US$ interest rates has resulted in the weakening of the yen and hence fuelling more yen-carry trades worldwide, including Malaysia” he said.

When contacted, Bank Negara Malaysia did not respond to queries for this article.

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