Yen Carry Trade Financing Risk Rises as Swiss Franc Emerges as New Favorite Funding Currency

The Japanese yen has historically been the dominant funding currency in global carry trades. However, with coordinated U.S.-Japan intervention efforts to strengthen the yen and growing expectations of Japanese interest rate hikes, investors are increasingly turning their attention to the Swiss franc (CHF). This shift is not only reshaping market dynamics but may also alleviate long-standing pressure on the Swiss government caused by an overly strong franc.

At the core of carry trading is the strategy of borrowing in low-interest-rate currencies and investing in higher-yielding assets—such as emerging market securities. Yet when the funding currency becomes volatile, exchange rate fluctuations can erase interest gains. Fredrik Repton, Senior Portfolio Manager at Neuberger Berman, noted, "Market participants are now considering rotating their funding positions."

Compared to the yen, which faces heightened volatility due to intervention risks, the Swiss franc’s appeal lies in its ultra-low interest rates and lower volatility. Adarsh Sinha, Head of G10 FX Strategy at Bank of America Global, stated, "Swiss franc rates are not only lower than yen rates, but the franc's volatility is also significantly lower." Currently, Switzerland maintains a policy rate of 0%, while Japan has raised its rate to 1%.

Moreover, Tobias Jungmann, Head of FX Options in New York at Bank of America, indicated that markets have recently increased short positions in CHF to finance carry trades. The favorable volatility-to-return ratio makes options an attractive hedging tool.

Beyond interest rates, central bank policy stances play a crucial role. Chris Turner, Head of Global Markets at ING, summarized: "Japan wants a stronger yen, while Switzerland prefers a weaker franc—making this transition logical." The Swiss National Bank (SNB) has repeatedly signaled it would intervene in forex markets if necessary to weaken the franc, a clear advantage for investors seeking low-cost funding.

Stephen Jefferies, Head of Foreign Exchange and Emerging Markets at JPMorgan, believes large-scale interventions in 2024 damaged carry trade returns, making investors more cautious and prompting them to explore alternative funding currencies such as the Swiss franc, euro, or even Taiwan dollar.

Data supports this trend: a strategy of borrowing CHF to invest in Mexican pesos yielded nearly 4% over the past month, compared to just 1.3% for a similar yen-based trade.

Despite rising interest in the franc, the yen’s status as the world’s primary funding currency remains entrenched in the short term. Markus Schmidt, Head of Linear FX Trading at Crédit Agricole, pointed out that the yen is still the dominant global funding currency, and recent interventions haven’t altered this fundamental reality. Turner from ING added that while the shift from yen to franc has begun, it remains in its early stages.