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One of the key drivers of the market lately has been the “yen carry trade.” A carry trade is when you can borrow money in a currency with low interest rates and turnaround and invest the proceeds in a currency with higher rates. You “carry” the proceeds from one asset to another. It’s like free money. That is, as long as the interest rates don’t move against you.

The popular carry trade has been to use the Japanese yen. The Bank of Japan used to have interest rates set at 0%, but it’s gradually raised rates to 0.5%. Switzerland has also been a popular currency of choice.

For example, a 10-year government bond in Japan goes for about 1.6%. In the U.S., 10-year Treasuries yield 4.5%, and in the U.K., Her Majesty’s 10-year bonds yield about 4.7%. The fear is that the carry trade will suddenly unwind—investors will close out of their carry trades all at once. So how much money is in the carry trade?

Japan's top financial diplomat Hiroshi Watanabe said he was closely monitoring yen carry trades and the impact from their possible reversal. He estimated the size of the carry trade at between 10-20 trillion yen but said there were no statistics available.

10-20 trillion? So he’s closely monitoring it, but he had no frickin idea.

Posted by edelfenbein at March 1, 2007 10:24 AM