Yen sheds 1% as carry trade unwinding leaves currency markets on edge

The yen was 1 percent lower at 145.78 per dollar in early trading on August 5

The US dollar extended steep losses on August 6, and the Japanese yen went down 1 percent after a sharp rise in the previous session as traders contend with unwinding of popular carry trades and the prospect of deep rate cuts from the Federal Reserve.

A carry trade is one in which money managers borrow in the currency with the lowest interest rates (yen, in this case), and deploy that money in other assets—equities, bonds, commodities, currencies—that offer a higher return. But when interest rates of the base currency start rising, the profit margins shrink, and the trades are liquidated.

The yen was 1 percent lower at 145.78 per dollar in early trade on August 5, after rising for five straight sessions and touching a seven-month high of 141.675 yesterday on August 5. The yen was also lower against the Australian dollar, euro and the sterling.

Disappointing US jobs data, Japan's interest rate hike, recessionary fears sparked a global sell-off in stocks, oil and high-yielding currencies on August 5 globally.

Global carry trades unwinding has also been boosting the Japanese currency and jolting markets around the world.

Also Read | Flashback: When yen carry trade unwinding worsened the 2008 global market meltdown

US central bank policymakers pushed back against the notion that weak July jobs data means the economy is in a recessionary freefall, but also warned that the Federal Reserve may have to cut rates in future to avoid such an outcome.

"Sell-offs that manifest themselves through wild swings in the currency markets are sharp and swift, but usually very short-lived," said Jamie Cox, managing partner at Harris Financial Group told news agency Reuters.

"Markets are clearly nervous about the divergent paths central banks are taking, leading to lots of volatility," Cox added.

The dollar index, which measures the US unit versus six rivals, was flat at 102.87 in early trading after touching a seven-month low of 102.15 yesterday.

The euro was little changed at $1.095275, while the sterling was slightly stronger at $1.2789.

Australian dollar was 0.45 percent higher at $0.6526 in early trading, after sinking to over an eight-month low of $0.63485 yesterday.

With agency inputs