Strategists at Goldman Sachs (NYSE:) are convinced that the recent unwinding of the carry trade with the Japanese yen (JPY) will continue despite the significant movements already observed.
The sharp sell-off that began late last week has drawn considerable attention to the extent of the yen carry trade unwinding and how long it may last. Strategists said the limited data available makes prediction difficult, although there are some key indicators to consider.
According to Goldman’s statement on Friday, while the latest CFTC data suggests that retail investors’ net short positions have fallen from nearly $15 billion to just $1 billion, that does not tell the whole picture.
“That alone would suggest that around 90 percent of the carry trade settlement has been completed,” the strategists said.
“While it is difficult to be confident in any estimate, we believe the actual number is likely lower. There is more room for upside given the significant holdings in ‘tougher’ parts of the investor space and positions outside of the futures markets.”
Goldman Sachs points out that the total foreign holdings of Japanese equity funds, public pension funds and other large investors have risen from 135 trillion yen before the start of the Bank of Japan’s aggressive monetary easing policy in 1998 to around 300 trillion yen in the first quarter of 2024.
Even assuming that only half of these investments are exposed to currency fluctuations, there is still a risk of significant losses of around US$1 trillion if the yen continues to appreciate. This could lead to further repatriation flows, amplifying both the equity sell-off and the rapid yen appreciation.
“However, any associated capital flows are likely to be slower on average than the rapid shifts that can already be observed in the speculator community,” the strategists continued.
“In addition, we are skeptical that the yen has been used so extensively as a direct financing factor for long positions elsewhere, particularly in the case of US technology stocks,” they added.
Rather, strategists believe that the recent correlation between the USD/JPY sell-off and price declines is due to a “perfect storm” of factors supporting the yen, rather than high leverage from the carry trade.
Nevertheless, if financial conditions in Japan tighten further sharply, it could disrupt domestic inflation developments and potentially hamper the Bank of Japan’s ongoing interest rate hike plans, as Vice Governor Uchida indicated. This is a key reason why Goldman Sachs believes a rapid and significant strengthening of the yen is unlikely unless there is a significant risk of a recession in the United States.
