Japanese overnight interest rates are still lower that the U.S. (10 basis points versus 25 basis points). However, the three month Libor rates show that it has been cheaper to borrow dollars rather than yen. In addition, the yen has been appreciating against the dollar since 2002. So those having to buy back yen (to unwind a carry trade) have had the extra burden of currency appreciation working against them.

Thus, the yen continues to appreciate against the dollar. However, this relationship is also approaching a critical resistance between 1.45 and 1.50. Can it power up over resistance? The bearish wedge formation suggests that it is not likely.
What has happened in the past six months has been that the yen and other high-beta currencies such as the euro, the pound and the

Australian dollar have all rallied with the equity indexes worldwide.

This is a departure from the pre-2002 relationship, where the yen was sold (short) whenever risk appetite increased. The traders back then took the proceeds and bought higher yielding currencies, such as the dollar.

Now the dollar is being sold in the new carry trade and the proceeds are being applied to the equity markets. Is this practice becoming long in the tooth? Let’s look at another relationship.

The Euro has also been appreciating against the dollar from the same low in 2002. What is different is that the bearish wedge has broken down in the euro-dollar ratio. The rally since March has been counter-trend. It has just exceeded the 61.8% Fibonacci retracement level, so the relationship may be ripe for a reversal.

The US dollar, on the other hand, is in the final stages of a descending (bullish) wedge. It, too, has completed its retracement of a wave 1 or A, and seems to be winding up for the pitch in wave 3 or C. If this analysis is correct, the carry trade that is now funded with borrowed dollars will have to be unwound, or the market will do it in the form of a margin call.

Bearish sentiment against the dollar is at an all-time high. Those with a strong set of beliefs against the dollar will find it very hard to part (even temporarily) from them. Strong rallies are made on the backs of panicked short sellers, as those caught short in equities in March will attest. An open mind and stop loss may be a good idea, if short the dollar.

In summary, those planning on a weak dollar funding a carry trade for the foreseeable future may be taking on a double risk; the first may be having the funding mechanism (dollar) become too expensive and the second may be the assets held may have more risk than what was bargained for. The yen carry trade may come back after all.

Our Investment Advisor Registration is on the Web

We are in the process of updating our website at www.thepracticalinvestor.com to have more information on our services. Log on and click on Advisor Registration to get more details.

If you are a client or wish to become one, please make an appointment to discuss our investment strategies by calling Connie or Tony at (517) 699-1554, ext 10 or 11. Or e-mail us at tpi@thepracticalinvestor.com .

Anthony M. Cherniawski,
President and CIO
http://www.thepracticalinvestor.com

As a State Registered Investment Advisor, The Practical Investor (TPI) manages private client investment portfolios using a proprietary investment strategy created by Chief Investment Officer Tony Cherniawski. Throughout 2000-01, when many investors felt the pain of double digit market losses, TPI successfully navigated the choppy investment waters, creating a profit for our private investment clients. With a focus on preserving assets and capitalizing on opportunities, TPI clients benefited greatly from the TPI strategies, allowing them to stay on track with their life goals

Disclaimer: The content in this article is written for educational and informational purposes only. There is no offer or recommendation to buy or sell any security and no information contained here should be interpreted or construed as investment advice. Do you own due diligence as the information in this article is the opinion of Anthony M. Cherniawski and subject to change without notice.

Anthony M. Cherniawski Archive

Only logged in users are allowed to post comments. Register/ Log in

The Market Oracle is a FREE Financial Markets Forecasting & Analysis web-site.
(c) 2005-2024 MarketOracle.co.uk (Market Oracle Ltd) - Market Oracle Ltd asserts copyright on all articles authored by our editorial team and all comments posted. Any and all information provided within the web-site, is for general information purposes only and Market Oracle Ltd do not warrant the accuracy, timeliness or suitability of any information provided on this site. nor is or shall be deemed to constitute, financial or any other advice or recommendation by us. and are also not meant to be investment advice or solicitation or recommendation to establish market positions. We do not give investment advice and our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to enter into a market position either stock, option, futures contract, bonds, commodity or any other financial instrument at any time. We recommend that independent professional advice is obtained before you make any investment or trading decisions. By using this site you agree to this sites Terms of Use. From time to time we promote or endorse certain products / services that we believe are worthy of your time and attention. In return for that endorsement and only in the cases where you purchase directly though us may we be compensated by the producers of those products.