Check out the descending triangle formation on the Yen.

Click on chart for a better view.

At the February 2005 peak in the Yen, the then current rage was that Buffett and Gates were short the dollar. The Yen then proceeded to collapse for two full years. Now after that collapse, here are a few comments from just the past several days.

Worries about the end of the carry trade are absolute nonsense” according to Stephen Massocca, president and head of trading at Pacific Growth Equities as attributed by MarketWatch.

There are really few reasons to extend the yen rally. The economic backdrop of the carry trade hasn’t changed. Japan still has low interest rates” said David Watt, senior currency strategist at RBC Capital Markets Inc. in Toronto, a unit of Canada’s biggest bank by assets.

That last quote is from Yen Poised for Best Week Since 2005 on Exit From Carry Trades. Following are a few other opinions from the same article.

“The momentum still favors an upside move in the yen in the short term,” said Todd Elmer, currency strategist at Citigroup Global Markets in New York. “Risk aversion is rising. It isn’t clear whether this has run its course.”

“We will probably see more unwinding of yen carry trade in the short term,” said Lara Rhame, a senior currency strategist at Credit Suisse in New York. “You have to take some risks off the table.”

“Given that valuations and positions are stretched in carry, we think the case for further follow through is compelling,” London-based Lehman currency strategist Phyllis Papadavid wrote in a research note today.

Unlike February of 2005 it’s hard to tell exactly what the prevailing sentiment is, or even if there is a prevailing sentiment, except to say that the carry trade players seem a bit more fervent in their support. Technically that chart pattern can break either way.

For some additional analysis on Japan, the Yen, and the Nikkei Index, there is an excellent article with many charts in the March 2007 Contrary Investor called Love Triangle? Following is one snip that I want to discuss:

A credit cycle underpinning more than a fair amount of global asset inflation over the past decade-plus as well as contributing to the dramatic lowering of risk premiums in many a financial asset class. We can assure you that the global central banking powers that be are critically aware of these circumstances. Moreover, Japanese institutions themselves have been big beneficiaries in this global liquidity expansion scheme in the modern day environment. Someday, somewhere, the Yen carry trade is going to turn on its benefactors. And given the enormous one-sided tilt in the carry trade arrangement, even partial unwinding of this “trade” could play havoc with many a financial asset price for a time. But, as always, the question is when? Let’s try to be realistic here; will the .25% rise in Japanese short rates now spark global financial market Armageddon as a result of this monetary baby step? We doubt it. … We also know many a global mover and shaker brought up the growth in global financial derivatives as a focal point at Davos recently. But does any central banker really want to see the golden goose of credit and excess liquidity driven asset inflation killed off? Not on your life. It’s the markets themselves that will most likely actually initiate the evil deed at some point. Probably when it’s least expected.

Maybe the key here is simply to watch the Yen and its response to monetary policy changes in Japan, if any near term. Again, we doubt the 25 basis point increase in short rates is going to cause the Yen to immediately rocket skyward, although some type of short term upward reaction is very possible. We believe the real problem for the carry trade would come if the G7 were to continue to be very vocal and ultimately put real pressure on Japanese authorities to raise rates.

Fundamental Factors

There can be no doubt that the credit cycle reached absurd levels in risk taking in subprime lending, leverage, derivative trading, yield spreads, and leveraged buyouts. Central bankers (at least some of them from Europe) seem to understand this. But every one of them embraced those activities. Whether or not Central Bankers want to see this end or not is now irrelevant. Credit speculation can only go so far before it blows up.

When it comes to the carry trade itself, those pointing out tiny hikes by Japan(so far) while concentrating solely on interest rate differentials are missing a big point. While it’s true that interest rate differentials are the biggest factor in currency movements; it is also true that it is the rate of change in interest rates as opposed to the absolute difference that is likely to matter most.

Not only is Japan hiking but the US is on the verge of cutting. This has a potential to matter far more than any of those asking “should I get back into the carry trade now” seem to think. Perhaps that expressed desire to rush right back into the carry trade after what is nothing more than a small blip on the weekly chart may be telling from the standpoint of sentiment. Furthermore, the US markets seem far more overvalued than the Nikkei. This is supportive of capital exodus from US equities into Japan.


  1. Technically we are at a spot where the Yen can break either way.
  2. Sentiment for the Yen is difficult to read but arguably conviction seems to be in the camp of the carry trade players. If true, this is bullish on the Yen.
  3. The rate of change in interest rate differentials strongly suggests a strengthening Yen.
  4. An overvalued S&P; compared to the Nikkei supports a capital exodus from the US to Japan.

In light of the above are “Worries about the end of the carry trade absolute nonsense“, or was that comment itself absolute nonsense?

Mike Shedlock / Mish/