By Chuck Butler

The G-7 made an unscheduled statement about the yen at a request of Japan's Finance Minister. Apparently, the yen’s strength is bothering Japanese officials.

The G-7 tried to stem the yen’s move higher, but the strength of unwinding carry trades is just too much to control. In fact, the yen has moved too far, too fast for such a watered down communiqué to do anything – especially when the G-7 just said they were concerned with the "excessive volatility." 

So, you have to sit down and attempt to figure out the depth of carry trades. In other words, how many more of those buggers are there?!

Well, I asked around on Friday (yes, I was at home, but still working, with two interviews, one radio and one Wall Street Journal, a long conference call, and this research on the carry trade) and found most traders who follow Japan seem to believe that this unwinding has much more to go. That means the yen should fly even higher, right?

Honestly, there’s no way to say for sure these days. But in keeping with the trading theme, I would say you can expect additional yen strength if carry trades unwind further. But that’s the easy answer. To get to the bottom of this trading theme, you have to think a little deeper on this carry trade issue…

For starters, these are not just plain old vanilla carry trades unwinding. Instead, traders are selling off years and years of Uridashi bonds.

For the new kids to class, Uridashi Bonds are Japanese Corp bonds that are issued in New Zealand dollars. The fact that they’re priced in New Zealand dollars gives them a huge yield advantage over Japanese yen denominated bonds. And Uridashi Bonds have been issued for years, which is a big part of why New Zealand dollars ran up in price over the last couple years.

There was a report by the Minister of Finance in Japan last week that showed the Japanese investors was unloading the Uridashi Bonds for the first time in years! And all this risk in the markets is not only causing carry trades to unwind. It’s also forcing Japanese investors to break the habit of investing anywhere but their home country.

So, no selling of yen, etc. Dorothy learned there was no place like home. So, it's about time the Japanese did too! So, unless the Bank of Japan (BOJ) is willing to intervene – and trust me they definitely could considering they have a war chest the size of Rhode Island of yen reserves to sell – then we should continue to see yen strength.

But then again, the BOJ always has a war chest of yen reserves that they could sell at any moment if the yen gets too high. In other words, yen can gain, but if the gain becomes too excessive, we could see the BOJ intervene.

With traders selling off Uridashi Bonds, the weakness in New Zealand dollars is magnified. I must have sounded like the Boy Who Cried Wolf over the years, warning about an unwinding of carry trades and what it might do to the high yielders. And now it’s here.