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Is “Yen Carry Trade” Being Replaced by “Dollar Carry Trade”?
Expansion of Dollar Carry Trade will devalue dollar and Dollars rush to the securities market in Korea
Is “Yen Carry Trade” Being Replaced by “Dollar Carry Trade”?
  • By matthew
  • October 15, 2009, 16:14
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'Dollar Carry Trade’ the act of borrow dollars at low interest rates and investing in products of high return is becoming popular due to the USA’s continued low interest rate policy. Last year, there were many who borrowed Japanese Yen to buy houses or build plants or invest in high-yielding bonds and securities. This is because the interest rate when borrowing Yen was very low. However, the dollar’s interest rate is now lower than the Yen’s resulting in more dollars being borrowing for investment.

As the USA keeps lowering base rates, the equation, ‘extremely low rates=Yen’ is fading. According to overseas news reports, it’s been 16 years since interest rates paid when borrowing dollars in international finance markets have lowered. On August 26, 2009, the three-month Dollar LIBOR (London Inter-Bank Offered Rate) on the London Market recorded 0.37188% a year, lower than the Yen LIBOR (0.38813%). This was the first time since May 1993 that dollar interest rates were lower than the Yen’s.

This is the reason why international finance market observes are claiming that the time of Dollar Carry Trade is coming. Carry trade refers to investment in securities or bonds of other countries by borrowing money from countries with relatively lower interest rates. When the borrowed currency is Yen, it is referred to as the Yen Carry Trade. As it involves borrowing at low interest rates, costs are lower and profits higher. However, under certain circumstances, devaluation of the currency may cause loss.

Before the global financial crisis, Yen Carry Trade was popular in the international finance market. This is because Japan lowered its base rate to zero in February 1992 and maintained extremely low interest rates. However, Dollar Carry Trade has begun to become popular with the USA lowering base rates to 0~0.25% as a measure against the financial crisis.

Dollar LIBOR lower than Yen LIBOR is a positive sign that the credit crunch from the USA has been alleviated. Dollar liquidity has been eased and policies have become more reliable. LIBOR is used as a benchmark to decide interest rates for corporate, mortgage and credit cards loans. In fact, in early October 2008 when the financial crisis was at its peak, the three-month Dollar LIBOR increased to 4.8%, while the Yen LIBOR for the same period was 1.09%. That this trend has been reversed has certainly come as a surprise.

The prospect that federal base rates will be maintained till at least the end of 2010 has experts believe resulted in lowering Dollar LIBOR. However, they warn that any increase of the interest rates will immediately reverse the LIBOR between the USA and Japan. There is also the prospect that the time to increase interest rates will come earlier than it did with Japan.

The reversion between Dollar and Yen LIBOR is a significant variable in the flow of international capital. A capital flow into a new market with borrowed dollars at low interest rates has been observed since April 2009 as dollar interest rates fell. Carry trade, which disappeared due to preference of safe assets such as US government bonds after the global financial crisis, came back. Analysts have observed that Dollar Carry Trade has become popular in international finance markets, particularly in countries where base rates will increase faster than the USA.

The primary subjects for Dollar Carry Trade include Brazil’s Real and the Australian Dollar whose currency value has increased by almost 30% this year. The investment strategy involves borrowing dollars at low interest rates, exchanging them into Brazil’s Real to invest, and then changing them back to dollars when the Real’s value increases, allowing profits from both interest rates and exchange rates.