The yen's renewed strength is pushing traders to hunt for other currencies to fund carry trades, with the Chinese yuan and Canadian dollar emerging as top contenders. Since Japanese authorities stepped into the foreign exchange market in late July, the yen has posted the biggest gains against the US dollar among Group of Ten currencies. Investors now expect the Bank of Japan to hike interest rates at its policy meeting this week.
As the yen continues its upward climb, traders are being forced to seek fresh funding currencies for carry trades, with the Chinese yuan and the Canadian dollar viewed as viable stand-ins. According to London Stock Exchange Group data, the yen has been the best-performing G10 currency since the Japanese government intervened in the market in late July, appreciating roughly 6% against the greenback. Meanwhile, Commodity Futures Trading Commission figures show that for the week ending September 8, speculators flipped to a net long yen position of about 10,800 contracts, a stark reversal from the prior week's net short stance of roughly 92,200 contracts.
The yen's surge has been fueled by hawkish signals from Bank of Japan board members, hinting at the possibility of accelerated rate hikes, an effect that has overshadowed even the historic joint US-Japan currency intervention. Adding to the pressure, US Treasury Secretary Scott Bessent has repeatedly warned speculative traders betting against the yen, stating last week: "I'm the house now." Carry trades, which involve borrowing in low-yield currencies to invest in higher-return assets, have lost their appeal in the yen as these factors converge.
Bank of America notes that the yuan is being viewed as a backup funding currency. Claudio Piron, the bank's head of Asia FX and rates, remarked: "When we talk about deflation, I often joke that Japan is becoming what China was 20 years ago." In an interview on the Asian Finance Forum show Friday, he added: "China's capital account is far less open than Japan's. However, we are seeing substantial offshore yuan bond issuance, with many multinational corporations choosing to raise funds and issue debt in that market." Last month, China held its loan prime rate steady for the 15th consecutive month, keeping the one-year rate at 3% and the five-year rate at 3.5%. While the offshore yuan trades more freely than its onshore counterpart, its movement remains heavily anchored to the onshore rate managed by the People's Bank of China.
The Canadian dollar has also caught investors' attention, with TD Securities FX strategists arguing in a report last week that the loonie could become a more attractive carry trade funding currency than the yen. They point out that the loonie's yield-to-volatility ratio has already reached parity with the yen. The strategists noted that while the currency weakened earlier due to US-Canada trade conflict headlines, there remains room for further depreciation as tariff shocks weigh on sentiment, corporate production, and ultimately feed through to domestic economic data. The Bank of Canada held its policy rate steady at 2.25% earlier this month.
Even with the yen's recent sharp appreciation, it doesn't necessarily signal the end of yen carry trades. Christopher Huang, FX strategist at OCBC Bank, says: "Market funds may see some rotation and repositioning. But even if the Bank of Japan hikes again, Japanese interest rates remain low by global standards." The BoJ is set to open its two-day policy meeting on Wednesday, with markets widely anticipating a 25-basis-point hike that would bring rates to 1.25%. For context, the US federal funds rate target range sits at 3.50%-3.75%, the Bank of England's rate is 3.75%, and the European Central Bank's rate stands at 2.5%.