Case? Japanese yen interest rates Over the past 20 years, Japanese yen interest
ID: 1216032 • Letter: C
Question
Case?Japanese yen interest rates
Over the past 20 years, Japanese yen interest rates have remained extremely low by global standards. For years, the monetary authorities at the Bank of Japan have worked tirelessly fighting equity market collapses, deflationary pressures, liquidity traps, and economic recession, all by keeping yen-denominated interests rates hovering at around 1% per annum or lower. These low-interest rates have spawned an international financial speculation termed the yen carry trade. It is a relatively straightforward speculative position: borrow money where it is cheap and invest it in a different currency market with higher interest returns. The only real trick is to time the market correctly so that when the currency in the high-yield market is converted back to the original currency, the exchange rate has either stayed the same or moved for the speculator, meaning the high-yielding currency has strengthened against the borrowed currency.
However, why the focus on Japan? First, Japan has consistently demonstrated one of the world’s highest savings rates for decades. This means that an enormous pool of funds has accumulated in the hands of private savers, savers who are traditionally very conservative. Those funds, whether stuffed in the mattress or placed in savings accounts, earn little in return. (In fact, given the extremely low-interest rates offered, there is little effective difference between the mattress and the bank.)
A second factor facilitating the yen carry trade is the sheer size and sophistication of the Japanese financial sector. Not only is the Japanese economy one of the largest industrial economies in the world, but it is also one that has grown and developed with a strong international component. One only has to consider the size and global reach of Toyota or Sony to understand the established and developed infrastructure surrounding business and international finance in Japan. The Japanese banking sector, however, has been continuously in search of new and diverse investments with which to balance the often despondent domestic economy. It has therefore sought out foreign investors and foreign borrowers who are attractive customers. Multinational companies have found ready access to yen-denominated debt for years—debt which is, once again, available at extremely low interest.
A third expeditor of the yen carry trade is the value of the Japanese yen itself. The yen has long been considered the most international of Asian currencies and is widely traded. It has, however, also been exceedingly volatile over time. However, it is not volatility alone, as volatility itself could undermine interest arbitrage overnight. The key has been in the relatively long trends in value change of the yen against other major currencies like the U.S. dollar, or as in the following example, the Australian dollar. Exhibit A illustrates the movement of the Japanese yen/Australian dollar exchange rate over a 13-year period, from 2000 through 2013.
Case questions:
1. Why are interest rates so low in the traditional core markets of USD and EUR?
2. What makes this “emerging market carry trade” so different from traditional forms of uncovered interest arbitrage?
3. Why are many investors expecting the dollar and the euro to remain weak?
Explanation / Answer
Answer 1:
This is because low interest rates are used to fight equity market collapses, deflationary pressures, liquidity traps and economic recession.
Answer 2:
The focus has been on Japan because of high savings rate in Japan. The second factor is the well developed financial sector. Yen is also considered the most international of all Asian currencies.
Answer 3:
Investors are expecting dollar and euro to remain weak because of the current economic conditions prevailing in the developed world facing recessionary conditions, high unemployment rates and low consumption, low investment. Thus, rate of interest are expected to remain low and dollar and euro are expected to be weak.