Carry trade

We believe it is important to stress that the term ‘carry trades’ is a misnomer of the true process that is taking place.

Japanese retail investors are raising their exposure to risky and higher-return assets and are not necessarily engaged in ‘carry trades’.

In fact, the monthly investment trust flows into foreign equities are about six to seven times larger than those heading into foreign bonds (Uridashis).

To us, it is more of a portfolio diversification, risk-seeking process than pure carry.

Interest rate differentials remain the driving force behind these moves, particularly for Japanese retail investors.

Japanese interest rates are on the rise.

The two year bond yields now 1% for the first time in a decade.

But it is the expectation of future rate changes rather than the absolute differentials that determine returns.

Most traders seem to be betting now that even if Japanese interest rates go up, rates elsewhere will rise by more.

The Australian dollar is on an 18 year high and Japan’s trade weighted exchange rate is at its lowest since 1985.

Even if the BoJ tightens once or twice more this year, it is far from clear that the JPY will rally.

Japanese retail investors are taking more risk, not just foreign currency risk. We believe that if the Nikkei starts to outperform, this trend outflow could be arrested and reversed.