Carry-trade investors that have been funding New Zealand dollar positions via the yen were busy buying downside kiwi dollar puts early last week to protect themselves in case the New Zealand central bank did not raise rates. In fact, the bank raised rates to 7.5% last Wednesday afternoon New York time, which immediately led to a kiwi dollar sell off.
Before the hike, investors were buying short-dated New Zealand puts up to one month against the yen with strikes around JPY75 range. Spot was at JPY79 on Thursday. One-month implied volatility on the pair touched an eight-month high hitting 14.8%.
The kiwi had already dropped 6% against the yen during the equity market chaos two weeks ago, dipping to JPY80.39, the lowest level in almost three months. This was prompted by concern that investors would start unwinding carry trades.
"Japan's kiwi exposure relative to the size of the overall kiwi market is really huge, which shows people were trying to use kiwi to lead the downside of high yielding currencies," said one trader
The yen continued its rally across all major currencies last week driven not by liquidation of carry trades, but due to Japanese institutional investors reducing their foreign currency denominated bond exposure ahead of the fiscal year end, said Naomi Fink atBNP Paribas in New York. This risk adjustment of Japan's institutional investors is not yet complete and suggests the yen will remain in demand, she added. A further increase in yen strength could undermine equity markets and increase asset volatility across the board.
