Yen Rally Pushes Carry Traders Toward Yuan and Canadian Dollar

The yen has become the best-performing G10 currency, appreciating roughly 6% against the dollar since late July. Investor positioning has shifted sharply alongside the rally, with speculators turning net long on the currency in the week through Sept. 8. That marks a significant reversal from the roughly 92,200 short contracts recorded just one week earlier.

Expectations for tighter monetary policy have been a major driver of the move. Hawkish comments from Bank of Japan officials have raised the possibility of faster interest-rate increases, while U.S. Treasury Secretary Scott Bessent has continued to caution traders against betting against the yen. The combination has made borrowing in yen less attractive for investors seeking to finance positions in higher-yielding assets.

Attention is consequently shifting toward China’s yuan. Bank of America sees the currency as a potential alternative, particularly as China continues to operate in a relatively low-rate environment. China kept its benchmark lending rates unchanged for a 15th consecutive month, with the one-year loan prime rate at 3% and the five-year rate at 3.5%.

The offshore yuan, or CNH, provides greater trading flexibility than its onshore counterpart, although it remains influenced by the People’s Bank of China’s management of the domestic currency. Bank of America’s Claudio Piron also pointed to growing issuance in the offshore yuan bond market and increased use of the market by multinational companies seeking financing. However, China’s tighter capital controls remain an important difference from Japan.

The Canadian dollar is another potential funding currency attracting attention. TD Securities said its carry-to-volatility profile is already comparable with that of the yen, while Canada’s policy rate stands at 2.25%. The currency could also face further depreciation if renewed U.S.-Canada trade tensions weigh on economic activity, production and investor sentiment.

Still, the yen carry trade is unlikely to disappear. Even if the Bank of Japan delivers an expected 25-basis-point increase to 1.25%, Japanese rates would remain low compared with other major economies. With U.S. rates at 3.50%-3.75%, the Bank of England at 3.75% and the European Central Bank at 2.5%, investors may rotate some funding toward other currencies rather than abandon the yen altogether.