Carry Trades Rebound as Profit Taking Comes to an End, Party Not Over Yet

Two days ago, we argued that the sell-off in carry trades represented profit taking rather than liquidation. Today, the strength of the rebound in the Yen crosses, particularly AUD/JPY, NZD/JPY and CAD/JPY confirm that it will take more than a mere correction to put an end to the carry trade.

At the first sign of trouble, traders piled right back into their Yen short positions. Japanese industrial production dropped 0.4 percent in the month of May, the third consecutive monthly decline in manufacturing activity. Analysts were looking for very strong growth; expectations were for industrial production to rise by 0.9 percent, bringing the annualized pace of growth up from 2.2 percent to 4.8 percent. Although retail sales and the corporate service price index reported earlier this week were strong, the drop in industrial production may prevent the Bank of Japan from raising interest rates in July or August. Before rushing to judgment, it is important to wait for tonight?s Japanese economic releases. We are expecting CPI, overall household spending, the jobless rate, and manufacturing PMI. Whether Japan sees inflation or deflationwill determine where the Yen is headed next.