Unwinding of yen-funded carry trades poses risk

LONDON (Reuters) - An unwinding of yen-funded carry trades poses a risk for financial markets as investors adjust to an environment of rising global interest rates, a hedge fund manager said on Wednesday.

Saleem Siddiqi, a founder at Tapestry Asset Management, said higher U.S. interest rates had already prompted investors to exit dollar-funded carry trades but many had simply switched their borrowing into yen.

Carry trades -- borrowing in a low-yielding currency to invest in one with higher returns -- have provided lucrative returns in recent years, but unforeseen bond and currency market shifts can trip up investors.

The Icelandic crown, for example, has fallen more than 10 percent against the euro in the past month as investors have piled out of the once high-flying currency, despite Icelandic interest rates of 11.5 percent.

"An unwinding of the yen carry trade is a huge risk," said Siddiqi.

"The classic carry trade of borrowing in dollars and investing in currencies such as the New Zealand dollar and Icelandic krona is already coming off, but the yen carry trade is still there."

The dollar's attractiveness as a funding currency has waned as the Federal Reserve has raised rates from 1 percent in 2004 to 4.75 percent last month.

Interest rates in Japan remain near zero but the central bank is expected to raise rates for the first time in six years later this year.

Siddiqi said macro hedge funds were well placed to benefit from a renewed focus on economic fundamentals.  Continued...