The yen carry trade — a “cheap money” borrowing ploy that may have financed investment in global risk assets worth hundreds of billions of pounds — is in danger of imploding.

Currency experts said that yesterday’s acute rise in the yen, particularly against sterling, the euro and the New Zealand and Australian dollars, was an “absolute” signal that the yen carry trade was unwinding — a consequence of the equity market turmoil spilling out from America’s sub-prime lending crisis.

The yen carry trade — the practice of cheaply borrowing yen to finance investments across the globe — is thought by some to be the core of the massive worldwide liquidity pool that is now contracting so violently.

The official interest rate in Japan, as set by the Bank of Japan is just 0.50 per cent, far cheaper than the price at which money has been readily available to borrow elsewhere. The carry trade has, for nearly a decade, exploited the near-zero interest rates at which money can be borrowed in Japan.

Although no firm data is available, many believe that the yen carry trade is the core support for strong markets everywhere — from energy and commodities to fine wine and property.

Certain emerging market economies with high interest rates, such as Turkey, may owe much of the strength of their currencies to investors who have sold borrowed yen to finance large positions in them.

“The scale of today’s movements in the yen,” said Tokyo Mitsubishi’s Derek Halpenny, citing an across-the-board flight from risk, “are clear evidence of a sudden liquidation of carry positions by hedge funds.”

He added that central banks have generally viewed the carry trade as a source of widespread mispricing of risk. But while central bankers may welcome some form of minor correction to that mispricing, the current turmoil will be a matter of grave concern. Hedge funds, believed to be the biggest users of the carry trade, have over the past two days become forced buyers of the yen as their overall positions have been squeezed by crashing stocks around the world.

Obliged to pay back the yen they have borrowed to buy shares — assets that are now worth substantially less than they were a week ago — carry trade investors have been forced to sell yet more stocks. The rising yen has also created margin crises for those who used borrowed Japanese currency to finance asset purchases in currencies that have now dived against the Japanese currency.

The unwinding carry trade presents many risks, which include the possibility that some highly leveraged funds might not have enough collateral as market conditions worsen.

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