Shinzo Abe in trouble -- End of yen carry trade?

June 27, 2007

Japan’s Prime MInister Shinzo Abe has been in office for only nine months, but already it looks like he is in trouble. His popularity rating has plummeted to 32%, just before Japan’s Upper House elections on July 29. If his party, the Liberal Democratic Party, doesn’t win a majority, then he will have little support for his economic policies.

One of the biggest impacts will be on the yen carry trade. The Bank of Japan (BOJ) has been reversing its recent policy of zero interest rates. The zero rate was needed to reverse Japan’s deflation and low economic growth. As Japan’s economy recovered in 2006, the BOJ raised rates in March and July, ending the year at .4%. (See BOJ to raise interest rate, 7/12/06 )

Prime Minister Abe’s economic policy has been to oppose those rate hikes. A low rate keeps Japan’s exports cheap compared to U.S. and other producers, who have to set prices in higher currencies. The BOJ has only raised rates once (on February 21, to .75%) since his election. If he doesn’t get political support in the November elections, then the BOJ would probably continue raising rates, strengthening the yen.

What Abe’s trouble means for the yen carry trade:
If the BOJ raises rates further, this could spell trouble for the yen carry trade. Global traders borrow yen at .75%, to invest in currencies such as the dollar that pay a higher rate of return (around 5%.). As the yen becomes more expensive, this source of liquidity will dry up. This will mean less investing worldwide, and economies will gradually slow.

The decline of the yen carry trade will also mean higher U.S. mortgage rates. Demand for U.S. Treasury notes has kept interest rates lower than even the Fed Funds rate, resulting in an inverted yield curve. As demand for Treasuries declines, their yields will increase which will drive up mortgage interest rates. Last but not least, the decline of the yen carry trade will drive up the value of the yen relative to the dollar. This could lead to a general decline of the dollar. (Source: Japan Times, “Abe: Election will be a referndeum,” June 25, 2007; Asia Economic Institute, “Bank of Japan and the Yen Carry Trade Bubble,” March 2007)

Action steps:
If the dollar declines too rapidly, it could lead to a dollar collapse. Find out how to stay ahead of the market by reading the WorldMoneyWatch Special Report, “The Dollar Collapse."

Yen carry trade related articles

G7 ignores weak yen, 2/14/07
Dollar weakens on BOJ report,11/08/06

Japan’s moderate expansion can reduce your risk, 5/20/06
Bank of Japan decides to tighten monetary policy,3/11/06
Yen carry trade, 12/28/05

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