The Japanese Yen has appreciated significantly, gaining nearly 10% against the US Dollar over the past three weeks, following multiple actions by the Bank of Japan and the local government.
Last week, the Japanese government confirmed a ¥36.8 billion intervention after the currency reached a 38-year low against the US Dollar. This was the second intervention since late May, following the first intervention since October 2022.
In response, the Bank of Japan raised its benchmark interest rates to "around 0.25%" from the previous range of 0% to 0.1%, marking the highest level since 2008.
The resulting appreciation has led to a significant unwinding of the "carry trade," a popular trading strategy in the currency market, impacting financial markets as well.
What is Carry Trade ?
Carry trade is a popular strategy in the currency market where investors borrow low-yielding currencies to invest in higher-yielding currencies.
Due to the Bank of Japan's ultra-loose policy and the weak yen, investors widely used the Japanese currency for carry trade. When the yen appreciates against the dollar, the carry trade results in losses. Consequently, the strengthening of the yen, a favorite currency for carry trade, prompted traders to quickly unwind their long positions in the yen, triggering a broad sell-off.
Yen-funded carry trades were among the most popular in emerging markets, as volatility remained low and investors expected Japanese interest rates to stay at rock bottom. However, the Bank of Japan raised rates for the second time at its latest meeting and indicated the possibility of further increases.
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