The End of the Yen Carry Trade II?

I first wrote about the potential for a dramatic unwinding of the yen carry trade back on May 19th. Click here to read that post. In light of the significant dislocation in the credit markets and the dramatic fall in equity prices around the world it was worth checking back in to see how the carry trade is holding up. The carry trade is a cheap way to borrow a low yielding currency like the yen (0.5%) and buy a higher yielding currency like the US dollar (5.25%), Australian Dollar (6.5%), or New Zealand Dollar (8.25%) in order to capture the difference in yields. All is well and good of course until the trade unwinds, which can happen quickly as traders flood the exits in a panic. Well that panic might be upon us:

``The market is in panic mode,'' said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon in New York, the world's largest custodian bank with over $20 trillion in assets under administration. ``It is a full-blown unwinding of the carry trade. This is just the beginning.''

Today the yen rose 3.5% against the US dollar. The yen is also strengthening dramatically against the other major currencies that are favored in the carry trade. Here's how the yen faired against other major currencies today.

The biggest change was the 8.837% appreciation against the Australian dollar and the 8.468% appreciation against the New Zealand dollar, both of which are popular carry trade currencies.

If we see a continued unwind in the carry trade that could be a bad sign for equities. We would see a more determined flight to quality situation and watch as short term treasury yields sink even further than they already have in the past week:
One way to play this would be to buy the yen ETF (EXY) which was up 2.25% today. I would stay away from (or short) the Powershares Currency Harvest ETF (DBV). That fund will get stung badly if the carry trade continues to unwind. I would also avoid most currency Etf's that are short the dollar, as I expect the dollar to continue to appreciate against the G-10.

>> Bloomberg Article
>> WSJ Article
>> Forbes Article