Yen Surge Pushes Carry-Trade Seekers Toward the Yuan and Canadian Dollar

The recent appreciation of the Japanese yen has prompted traders engaged in carry trades to reconsider their funding strategies, with the Chinese yuan and the Canadian dollar emerging as potential alternatives.

Since late July, when Japanese authorities intervened in currency markets, the yen has recorded the strongest performance among Group of 10 currencies, gaining approximately 6% against the U.S. dollar. This shift has been further fueled by hawkish rhetoric from Bank of Japan board members regarding possible accelerated interest rate hikes, alongside warnings from U.S. Treasury Secretary Scott Bessent to speculators betting against the yen.

Data from the Commodity Futures Trading Commission indicates that speculators flipped their stance in the week ending Sept. 8, establishing a net long position of roughly 10,800 yen contracts compared to the previous week’s net shorts of 92,200. Consequently, the yen has become less attractive as a funding currency for investors who borrow in low-yielding assets to invest in higher-yielding ones.

Bianca Piron, head of Asia forex and rates at Bank of America, noted a dynamic inversion between the two economies, quipping that Japan resembles China from two decades ago regarding deflation, while China is taking on characteristics once associated with Japan.

“The openness of the capital account of China is much more restricted than that of Japan,” Piron said on CNBC’s “Squawk Box Asia.” However, he highlighted a surge in CNH bond issuance and increased funding activity by foreign multinationals in those markets. China recently maintained its benchmark lending rates unchanged for the fifteenth straight month, with the one-year loan prime rate holding at 3% and the five-year rate at 3.5%.

Meanwhile, strategists at TD Securities have identified the Canadian dollar as an increasingly viable option. In a report published last week, they pointed out that the loonie’s carry-to-volatility ratio is already comparable to that of the yen. Although the Canadian dollar weakened following recent tit-for-tat tariffs between the U.S. and Canada, the bank believes there remains room for further depreciation as the trade shock impacts sentiment, production, and domestic economic data. The Bank of Canada kept its policy rate steady at 2.25% earlier this month.

Despite the yen’s resurgence, experts suggest the classic yen carry trade is not yet over. Chris Wong, a forex strategist at OCBC, stated that while market rotation is possible, Japanese interest rates will remain low by global standards even after an expected 25-basis-point hike to 1.25% at the Bank of Japan’s policy meeting beginning Wednesday.

For context, the U.S. federal funds target range sits between 3.50% and 3.75%, the Bank of England’s rate is at 3.75%, and the European Central Bank’s rate stands at 2.5%.