Yen Rally Sends Carry Traders Hunting for New Funding Currencies

The Japanese yen's renewed strength has carry-trade investors searching for new funding currencies, with the Chinese yuan and the Canadian dollar now in the frame. The yen has appreciated about 6% against the dollar since late July, when Japanese authorities intervened in the currency market, according to LSEG data. That makes it the best-performing currency in the G10 group.

Speculators flip to long yen

Positioning has shifted sharply. Speculators flipped net long on the yen in the week to Sept. 8, according to the Commodity Futures Trading Commission. Those positions totalled around 10,800 contracts, compared with roughly 92,200 yen short positions the week before.

Hawkish comments from Bank of Japan board members, which left open the possibility of faster rate hikes, have done more to lift the yen than the historic joint U.S.-Japan intervention managed. Treasury Secretary Scott Bessent also kept the pressure on speculators, warning last week: "I am the house now."

All of that weakens the yen's appeal as a funding currency, the role it has played for years in carry trades where investors borrow in low-yielding assets to buy higher-yielding ones.

Yuan and Canadian dollar in the frame

Bank of America has floated the Chinese yuan as a contender. "I like to quip that Japan is becoming like China was 20 years ago, and China is becoming like Japan" on deflation, said Claudio Piron, head of Asia forex and rates, speaking on "Squawk Box Asia" on Friday.

"The openness of the capital account of China is much more restricted than that of Japan," he said. "But we've seen a lot of issuance in CNH bonds, and a lot of foreign multinational companies seek funding and issuance in those markets."

China kept benchmark lending rates unchanged last month for the 15th consecutive month, with the one-year loan prime rate at 3% and the five-year rate at 3.5%. The offshore yuan trades more freely than the onshore currency but remains largely anchored to it, and the onshore rate is managed by the People's Bank of China.

The Canadian dollar is also on investors' radar. TD Securities expects it to become a more compelling carry-trade funding currency relative to the yen, with forex strategists saying in a report last week that its carry-to-volatility ratio is "already comparable to the Japanese yen." The loonie weakened after the latest round of tit-for-tat tariffs with the United States, and the strategists said it still has room to depreciate as the tariff shock hits sentiment and production, and eventually domestic economic data. The Bank of Canada held its policy rate at 2.25% at a meeting earlier this month.

Yen carry trade not dead yet

The yen's latest run does not necessarily mean the end of the yen carry trade. "We could see some rotation," said Chris Wong, forex strategist at OCBC, but "even after another BOJ hike, Japanese rates will still be low by global standards."

The BOJ begins a two-day policy meeting on Wednesday, where a 25 basis point hike to 1.25% is expected. For comparison, the federal funds target range sits at 3.50% to 3.75%, the Bank of England's rate at 3.75%, and the European Central Bank's at 2.5%.

For Nigerian businesses and the naira, the rotation matters at the margin. Carry trades are funded in currencies like the yen and deployed into higher-yielding markets, so any shift in where that funding comes from feeds into the flow of hot money across emerging and frontier markets, including Nigeria's.