Traders shift carry funding from yen to Swiss franc

Hedge funds are shifting funding for carry trades away from the Japanese yen and toward the Swiss franc after recent U.S.-Japan intervention increased the risk of losses on short-yen positions. Swiss policy rates are 0%, compared with 1% in Japan.

Carry trades involve borrowing in a low-interest-rate currency and investing in higher-yielding assets. The strategy relies on small interest-rate differences and stable exchange rates for the funding currency.

The yen has long been a common funding currency because of its deep liquidity and high trading volumes. Coordinated official support for the yen and signs that Japanese rates may rise have led some managers to reduce their short-yen exposure and, in some cases, partially unwind positions.

The Swiss franc has emerged as an alternative funding currency. Swiss interest rates remain lower than Japan’s, and the franc has shown lower volatility than several other major currencies. The franc has eased from recent peaks and is trading near 0.9385 against the euro. Against the U.S. dollar it has fallen almost 7% from an 11-year high earlier this year.

Market forecasts have moved to reflect the change in outlook. One bank raised its nine- to 12-month euro/Swiss franc forecast to 0.95 from 0.94, indicating an expectation of further franc depreciation.

Policy positions are affecting investor choices. The Swiss National Bank has said it is prepared to intervene to restrain excessive franc strength that could hurt exporters and growth. Officials’ willingness to act can reduce the probability of sharp franc appreciation. In contrast, the recent U.S.-Japan support for the yen and signals of possible future rate rises in Japan increase the chance of sudden moves in the yen.

Trading data show some reduction in outstanding short-yen positions, bringing those levels closer to short positions in the Swiss franc. Low foreign-exchange volatility this year has supported carry strategies and helped them produce strong returns, while sharp moves in a funding currency can quickly eliminate the interest-rate advantage.

Other factors adding uncertainty for the yen include expectations of further Japanese rate increases and the possibility that Japan’s Government Pension Investment Fund could raise domestic allocations, which would reduce global selling pressure on Japanese assets. These developments, combined with intervention risk, have prompted hedge funds to reassess how much yen exposure to hold rather than to exit the market entirely.

Market participants still view the yen as a major funding currency because of its liquidity and trading volume. At the same time, the mix of intervention risk in Japan and a more accommodative Swiss policy stance has led some managers to diversify funding sources toward the franc as a way to manage currency and funding risks.