The Dollar-Yen carry trade: Is it worth the risk?
Most of that disparity has come not from labour markets, but financial markets. Recent yen weakness has been driven by lower interest rates in Japan versus the rest of the world, particularly the US. But in fairness, the dollar has had everything going for it. Helped by massive government spending, the US economy held up much better than others coming out of COVID. The US is largely energy independent, insulating it from rocketing gas prices in the wake of Russia’s invasion of Ukraine. And in times when other assets look shaky, the US dollar remains the world’s reserve currency and a “safe haven” for fearful investors.
All that has made the dollar-yen carry trade—borrowing yen to buy dollars to take advantage of the difference in interest rates—a lucrative one in recent years. But in our view, carry traders could be caught collecting pennies in front of a steamroller.
To us, the current difference of 40% in yen versus dollar purchasing power is too extreme to last. If less than everything continues to support the dollar, its tailwinds could rapidly become headwinds. Topping the list is interest rates, which are likely to fall in the US as short-term inflation moderates.
Japan’s yen: Ready for a comeback?
On the other side of the Pacific, factors appear to be turning more favourable for the yen. Inflation that had been absent for decades appears to be back, and on 31 July, the Bank of Japan raised interest rates to a lofty 0.25%— the highest it has been since late 2008 amidst the fallout from the global financial crisis.
Inflation should continue to be supported by rising wages. After decades of receiving only meagre pay increases, in March this year Japanese workers secured their highest pay rise in 30 years. This comes with an apparent recognition by all stakeholders that a reasonable level of wage growth is beneficial for the economy as a whole.
Lastly, a weak yen makes Japan an attractive place to visit as a tourist (it’s not just the Big Macs that are cheap!). After three years lost to the COVID pandemic—Japan was much slower than elsewhere to reopen—visitor numbers are reaching record highs, with almost 18 million tourists arriving in the first half of 2024. That is despite the fact that numbers of Chinese tourists—having made up the largest group of visitors pre-COVID—are still yet to return to 2019 levels. Tourists from the US and South Korea are making up an increasingly large proportion of visitors spending big on hotels, in restaurants and in shops. And all that spending requires selling dollars to buy yen, providing a further boost to the currency.
