The Flurry on Carry Trade Continues

I just reported on this a couple of days ago but apparently the commotion on the much debated Yen carry trade is picking up speed as we draw near to the G8 meeting in Germany where the Yen is sure to be on the agenda.

(from Bloomberg - linked above) 

European governments will next week warn the Bank of Japan that a reluctance to raise interest rates risks distorting the value of an already weak yen, according to a confidential report prepared for a meeting of finance chiefs from the Group of Seven nations.

``The bank should consider the potential drawbacks of a policy of accommodation,'' said the draft document drawn up for Luxembourg Prime and Finance Minister Jean-Claude Juncker, who attends G-7 meetings as the representative of the 13-nation euro region. Leaving Japanese rates low threatens ``possible distortive effects on the currency and increased risk of disorderly adjustment of the global imbalances,'' according to the document, which was obtained by Bloomberg News.

The FT also has the story ...

The yen hit a four-year low against the US dollar on Monday, intensifying fears that the rising level of currency-based “carry trades” by hedge fund investors could jolt markets if these positions were suddenly unwound.

The Japanese currency’s sharp fall also prompted European finance ministers to voice concern about its weakness. Jean-Claude Juncker, the chairman of the eurozone’s 13 finance ministers, said he was “increasingly a little bit worried” about the yen. The currency dropped to a record low of Y158.60 to the euro last week. On Monday, it fell to Y122.19 against the dollar.

Many economists and bankers suspect that carry trade activity is an important factor behind the yen’s weakness.

Finally, the excellent Eurointelligence site also presents a slew of articles on the debate. The question of course remains as to whether this will have any effect. I mean they tried this last time as well I remember and back then talk turned out to be incredibly cheap. The main issue here is the fundamentals of the Japanese economy which clearly facilitates the continuation of carry trade which indeed may be an unwanted phenomenon from the point of view of financial stability. However, by focusing on the effect (carry trade) rather than the source (the fundamentals of the Japanese economy) we are missing the big picture of what is really going on.