The mighty Yen

Don't be mislead by the weakening exchange rate of the Yen against the other major currencies into thinking that the Japanese economy is doing badly. On the contrary, the Japanese economy is on positive growth. The weak exchange rate is just an aberration caused by the exceptional low interest rate in Japan. At the current exchange, the Yen is very much undervalued.

The official lending rate in Japan is only 0.5% - the lowest among the major economies. There is a substantial interest rate differential between Japan and the other countries, especially New Zealand. This has encouraged huge outflow of funds in so called carry trades. Japanese are, in droves, using margin accounts to borrow Yen and place deposits in higher yielding foreign currencies. This has caused the higher yielding currencies like the Kiwi and Aussie dollars to rise.

Hedge funds have also been borrowing Yen to invest in higher yielding assets like Chinese stocks. The unwinding of the carry trade on Chinese stocks was blamed for nearly causing a global market meltdown in late Febraury this year.

The Japanese government is expected to raise interest rates later this year. What happens when the local interest rate is deemed high enough and the Japanese start to unwind their carry trades. Will it cause a tremor in the global financial market. Lets hope that this unwinding will be done gradually and hence not cause too much of a ripple in the market.