by Kathleen Brooks

Japan's economy has been hit badly by the recession, partly because the yen, Japan's currency, has risen steeply since the start of the financial crisis. A stronger yen makes Japanese exports more expensive, which is bad news for that country's economic growth.

To get the economy moving again, there is some talk that the government could try to depress the yen's value by encouraging a return of the carry trade.

 

One way they are doing this is by cutting interest rates.

The mechanics of a carry trade work like this: you sell a currency with a low interest rate, like the Japanese yen, whose rates are 0.1%, and you buy assets with a higher interest rate, like Australian fixed-income securities, with interest rates of 3%. The difference between them — 2.9% — is the carry, and this is what an investor earns from the trade. Not bad, since short-term U.S. Treasury bonds have a yield of less than 1%.

The carry trade was a hallmark of the pre-financial crisis years. Throughout 2006 and 2007, the yen fell and the Australian and New Zealand dollar soared in value.

When the value of the yen started to move upward, the carry trade lost its celebrity status very quickly.

But recent action in the markets show there are some tentative signs that investors are returning to the carry trade. The Australian dollar is at a six-month high and the yen has fallen in value.

Carry trades remain risky business. When the yen began to rise at the start of the financial crisis, investors holding on to carry trades found they were losing money. They borrowed yen in the hope it would continue to lose value — but they ended up paying it back at a higher rate.