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Unwinding of the "Yen Carry Trade" is Bearish for Global Stock Markets

Stock-Markets / Yen Carry Trade Mar 26, 2008 - 10:32 AM GMT

By: Donald_W_Dony

Stock-Markets Best Financial Markets Analysis ArticleGlobal equity traders had, for many years, a ready source of funds at almost no interest charge. Traders have been shorting the Yen and using the funds to purchase stocks, currencies and high-yielding securities around the world. However, as of mid-2007, that "free bank account" is becoming more and more costly. The Yen carry trade is starting to unwind with very negative results for stocks.


But what is the "Yen carry trade"? Simply put, it is borrowing at very low interest rates in Yen and using the loan to buy higher yielding assets elsewhere. During the past 12 years, the trade has become standard business practice for many institutional investors. Perhaps the most popular form of the strategy exploits the yield gap between U.S. and Japanese fixed income securities. Another plus that came with the Yen/U.S. cross was from the dollar's rise against the yen. Investors make their profit when they reverse the trade and pay back the Yen loan.

But all of this endless liquidity is quickly coming to an end and with bearish consequences to global equity markets.

Chart 1 illustrates the tight connection of the Japanese currency with global stocks. With every major rise of the Yen throughout 2007, there was a mirrored decline in the Dow Jones World Stock Index. Quite simply, the global equity markets began to fall when the tap was turned off to cheap money. Traders are now forced to buy back massive Yen short positions and sell assets to pay for it.

And what is happening to the Yen? Chart 2 shows the Japaneses currency is breaking through a decade old resistance levels and surging to new highs. And this trend shows no signs of reversing. The upside target is 120.

Bottom line: The bearish impact of the advancing Yen is clearly apparent on global stock markets. World equities appear to have been propped up largely due to the availability of foreign liquidity. As this "cheap money" is quickly evaporating, so is the global bull market.

Additional market analysis and recommendations can be found in the March newsletter. Go to www.technicalspeculator.com

By Donald W. Dony, FCSI, MFTA
www.technicalspeculator.com

COPYRIGHT © 2008 Donald W. Dony
Donald W. Dony, FCSI, MFTA has been in the investment profession for over 20 years, first as a stock broker in the mid 1980's and then as the principal of D. W. Dony and Associates Inc., a financial consulting firm to present.  He is the editor and publisher of the Technical Speculator, a monthly international investment newsletter, which specializes in major world equity markets, currencies, bonds and interest rates as well as the precious metals markets.   

Donald is also an instructor for the Canadian Securities Institute (CSI). He is often called upon to design technical analysis training programs and to provide teaching to industry professionals on technical analysis at many of Canada's leading brokerage firms.  He is a respected specialist in the area of intermarket and cycle analysis and a frequent speaker at investment conferences.

Mr. Dony is a member of the Canadian Society of Technical Analysts (CSTA) and the International Federation of Technical Analysts (IFTA).

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