Yuan vs. Yen vs. Franc: Shifting Carry Trade Strategies

Forex 5 minutes to read
Charu Chanana 400x400
Charu Chanana

Head of FX Strategy

Key points:

  • Carry trades remain popular when there are interest rate gaps between different currencies and volatility is low. JPY and CHF have traditionally been key carry funding currencies.
  • However, higher volatility in Japanese yen due to intervention risks and the probability of BOJ normalization as well as haven flows in CHF are sending some cautionary signals on carry trading.
  • Amid these challenges, the Chinese yuan (CNH) with controlled depreciation and low rates may become a more attractive option for carry trades.

Carry trading is a popular investment strategy where traders borrow money in a currency with a low interest rate and invest it in a currency with a higher interest rate. The goal is to capture the difference between the interest rates, known as the "carry." This strategy is particularly attractive in times of low volatility, as it relies on stable exchange rates to avoid eroding the gains from interest rate differentials. We discussed more about carry trading in this article.

Historically, the Japanese yen (JPY) and the Swiss franc (CHF) have been the primary funding currencies for carry trades. Both currencies have maintained low interest rates for extended periods, making them cheap to borrow.

However, going into H2, investors may be re-assessing carry strategies with yield differentials likely to narrow, and geopolitical risks expected to spook volatility. These factors challenge the fundamental principles of carry trading—low volatility and interest rate gaps. Consider the below factors:

  • Yen Volatility: Recent policy changes by the Bank of Japan (BOJ), including adjustments to its negative rates and yield-curve control policy, have contributed to increased volatility in the yen. Despite these shifts, Japanese yields remain low, causing the yen to weaken further. This instability makes the yen less attractive as a funding currency for carry trades.

  • Potential Yen Intervention and BOJ Normalization: The possibility of the BOJ intervening in the currency market to stabilize the yen adds another layer of uncertainty. Additionally, prospects of the BOJ normalizing its monetary policy could lead to increased volatility, further discouraging the use of the yen in carry trades.

  • Geopolitical Risks and CHF Safe Haven Flows: The Swiss franc (CHF) is another potential funding currency due to its low interest rates. However, rising geopolitical risks amid the France elections have led to haven flows into the CHF, reducing its attractiveness for carry trades. Going into the second half of the year, geopolitical risks are expected to remain a significant concern for investors, as we approach the US presidential elections in November. This could continue to drive safe-haven flows into the franc, reducing its appeal for carry trades.
3_FX_CNH Vol
Source: Bloomberg

    These factors could make the Chinese yuan (CNH) a more favorable funding currency compared to the JPY and CHF. The People's Bank of China (PBOC) is deliberately guiding the yuan to a weaker position to support the economy and boost exports. This controlled depreciation, combined with low domestic interest rates, suggest yuan could remain on the path of weakness without any immediate concerns of volatility. Q3 will also likely see more volatility around US elections, and the possibility of a second Trump presidency could be seen as a negative for yuan due to tariffs risks.

3_FX_CNY Fix

However, using yuan as a carry trade funder comes with its risks. The Chinese authorities tightly manage the yuan's value through daily fixings and intervene in markets to prevent excessive depreciation, which can limit potential profits from the trade. Moreover, the yuan's liquidity and accessibility in global markets are not as robust as major currencies like the Japanese yen, affecting execution and hedging strategies. Regulatory changes and geopolitical tensions further complicate the landscape, influencing the yuan's stability and attractiveness for carry trades. Therefore, investors considering the yuan for carry trades should closely monitor regulatory policies, market conditions, and geopolitical developments to mitigate risks effectively.



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