Hedge fund investors are beginning to look beyond the Japanese yen for funding currencies in carry trades, with the Swiss franc emerging as a potential beneficiary of recent intervention in the foreign exchange market, according to a report by Reuters.
The shift follows rare US-Japanese efforts to support the yen, which have increased the risk for investors betting on a weaker Japanese currency. The yen has traditionally been one of the preferred funding currencies for carry trades, in which investors borrow cheaply in a low-interest-rate currency and deploy the proceeds into higher-yielding assets, often in emerging markets.
Analysts and investors say the prospect of further intervention, alongside expectations for higher Japanese interest rates, is prompting some market participants to reassess their exposure.
The Swiss franc could offer an alternative because Swiss interest rates remain lower than those in Japan, while the currency has also historically exhibited relatively low volatility.
Swiss rates are currently at zero, compared with 1% in Japan, according to the report.
The franc has already weakened against several major currencies following a period of significant strength. It is trading around 0.9385 against the euro, roughly 4% below its March peak near 0.90, which was its strongest level in 11 years. Against the US dollar, it has fallen almost 7% from an 11-year high reached in January.
Rabobank has raised its nine- to 12-month forecast for euro/Swiss franc to 0.95 from 0.94, signalling expectations for further franc depreciation.
For Swiss policymakers, a shift towards using the franc as a funding currency could be welcome. The Swiss National Bank has previously indicated that it is prepared to intervene if necessary to curb excessive strength in the currency, which has weighed on exporters and economic growth.
The franc nevertheless remains considerably stronger against the euro than it was five years ago, supported by Switzerland’s persistent current-account surplus, strong public finances, low inflation and safe-haven demand.
The yen is unlikely to lose its status as a major carry-trade funding currency overnight, given its deep liquidity and position as one of the world’s most actively traded currencies.
However, the intervention threat has made short-yen positions less straightforward. Expectations of further Japanese rate increases and the possibility that Japan’s Government Pension Investment Fund could increase domestic allocations are also adding to uncertainty around the currency.
Recent intervention has already encouraged some investors to unwind yen shorts, bringing outstanding short positions closer to levels seen in the Swiss franc.
The broader backdrop remains supportive for carry strategies. Low foreign-exchange volatility has helped carry trades deliver some of their strongest returns in years, but the strategy becomes more vulnerable when funding currencies experience sharp moves that erase the advantage provided by interest-rate differentials.
For hedge funds running carry strategies, the combination of Japanese intervention risk and a potentially more accommodating Swiss policy stance could therefore accelerate a gradual diversification away from the yen.
