EUR/JPY weakens as China stimulus revives carry trade, weighing on Yen

• China’s massive stimulus package has supported emerging market currencies, reviving the carry trade.
• This is weighing on the Yen, which is a popular funding currency for carry trades.
• BoJ comments and weak Eurozone data weigh on EUR/JPY.

EUR/JPY is trading at 160.20, up almost 0.40% on Tuesday, after the announcement of substantial stimulus measures by China revived the carry trade, weighing on the Japanese Yen (JPY), the most popular funding currency for such trades.

The carry trade is a trade in which traders borrow money in a currency with low interest rates, such as the Yen (around 0.25% APR) and use the money to buy a currency with a high interest rate, such as the Mexican Peso (10.75% APR).

The carry trader profits from the difference between what it costs to service the loan and the interest earned. Because the Yen is so popular as a funding currency, the rise in the carry trade can be a negative factor. China’s stimulus package has revived the carry trade because it had the side effect of supporting emerging market currencies, such as the Mexican Peso (MXN), making the trade even more profitable.

The EUR/JPY is below the day’s high of 161.11, however, due to a speech by Bank of Japan (BoJ) Governor Kazuo Ueda, which helped strengthen the Yen. The Euro (EUR) also lost some momentum due to more negative data from Europe’s largest economy, Germany.

Kazuo Ueda was moderately hawkish (i.e. in favor of raising interest rates) in his comments on Tuesday morning. He said that if inflation continues to rise in line with the BoJ’s latest forecasts, it would mean the bank would raise interest rates, which is positive for the Yen.

“We will raise the interest rate if the economy and prices move in line with the forecasts shown in our quarterly outlook report,” Ueda said.

A below-expected result for Germany’s IFO business sentiment index in September, a survey of 7,000 companies, further acted as a headwind for EUR/JPY.

Both the IFO Business Climate and Current Assessment indexes fell below previous readings in August and below economists’ forecasts. The IFO Outlook index, meanwhile, was in line with forecasts but still below the previous month’s reading. The data reinforces the view that the German economy is at risk of falling into recession.

The Euro lost ground on most of its peers on Monday after the release of HCOB Purchasing Managers’ Index (PMI) data, which showed a sharp drop in activity in the Eurozone economy, with the Composite PMI turning from growth to contraction.

In contrast, the Jibun Bank PMI in Japan, while showing a slight contraction in manufacturing, showed a slight increase in service sector activity.