Carry Trade Beginning to Unwind

Nearly two months ago, China’s stock market declined 15% in one session, leading capital markets around the world to drop off precipitously. This collapse quickly spread to forex markets, where spooked traders began to unwind their Japanese yen carry trades, fearful that the volatility would trigger a short squeeze, causing the Yen to rapidly appreciate. While the yen has returned to its former low levels, it seems foreign investors have prudently unwound up to 60% of their short positions in the Yen, anyway.

A quandary has plagued analysts, who are attributing the failure of the Yen to appreciate to a surge of carry trade interest by Japanese retail investors. Long term Japanese interest rates remain pathetically low, and Japanese investors have taken to buying securities in American and Australia, where yields are significantly higher. However, if Japan's Central Bank begins to raise rates- as analysts expect will take place as soon as May- investors could be persuaded to repatriate their capital to Japan. The Economist reports:

Retail investors’ direct share of Japan's foreign-currency market may be 20-30%, whereas individuals’ holdings of foreign currency exceed foreigners' holdings of Japanese securities. The clue to the yen's future, in other words, lies with the little man.