Tuesday, April 25, 2023

Should we expect a depreciation of the yen?

 Arbitrage 101:  Borrow ¥ in Japan at 2%, sell ¥ to buy $, and invest $ in US bonds earning 5%.

And the expected change in exchange rates make makes it cheaper to pay back the loan! 

Here's why.  As more US investors take advantage of this "carry trade," the increase in demand for dollars will increase the price of a dollar (in yen) which reduces the cost of repaying the loan (when you sell $ to buy ¥ to pay back the loan).


The above graphs shows an appreciation of the dollar, or a depreciation of the yen, over the last 18 months. 

The surge in American but not Japanese interest rates over the past 18 months means that Japanese investors are paying an enormous premium to buy American assets and protect themselves from currency movements. American investors get a rather lovely premium when they do the same in the other direction. 

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