The global rout in equities amid concerns that the sub-prime mortgage problem in the US is spreading led to the yen touching a 52-week high to the dollar. It touched 113.90 in intra-day trade. Analysts feared that if the yen would appreciate above the 116 levels there could be some real damage due to unwinding as the damage of a potential yen carry trade unwinds could be very devastating for emerging markets.

The yen appreciation comes at a time when global markets are quivering under the impact of a sub-prime mortgage problem in the US. There are also concerns that widening credit market losses have prompting investors to cut holdings of higher-yielding assets funded by loans in Japan.

This could have huge fallout in India as well as a number of domestic companies had tied up loans when the yen was depreciating, which was to be settled in dollars. Now, the tide is starting to turn. Rising interest rates of the yen may push costs of yen carry trade up, which is a swap cost for borrowing in the yen and converting into the dollars to invest and take advantage of low interest rates on the Japanese currency. The Bank of Japan, or BoJ, may also raise interest rates in its August 23 meeting.

So, where do analysts see the yen heading?

Juerg Kiener, MD and CIO, Swiss Asia Capital, said the yen carry trade has been unwinding, not collapsing and the trend is not over yet. “We have been on the yen at about 123, it is now at 115, and we may go down to 110. On Aussie dollar, the carry trade was huge; we basically lost 10% in three days. The New Zealand dollar has a huge carry trade particularly against the yen. In a week, we have lost 14% against the dollar and about 18% against the yen. The carry trade has been unwinding and creating huge losses for some peoples’ pockets and these pockets have to be refilled. So the carry trade is unwinding, but is no collapsing. It is a long high yield place and the commodity currencies, which have been taking the brunt of unwinding, that might not be over yet," he added.

Robert Horrocks, Head of Research, Mirae Asset Global Investment Management, feels the yen could appreciate further due to unwinding of carry trade positions. “The current volatile conditions are likely to continue for a little while. We will probably see a further depreciation in the rupee in line with depreciation of other currencies across the Asian region, with the exception of the yen, which could see further strength due to the unwinding of carry trade,” he added.

Jan Lambregts, Director- Head of Research (Asia), Rabobank International, said the fundamentals in Japan remain strong and global carry trades have affected the yen. The yen could regain structural composure slowly from here, he added.

“It is a scenario that we have to take into account. If the yen strengthens it could start to feed upon itself. If you are looking at the fundamentals of the yen weakness over the past couple of years, it has been the carry trade, which was founded on, yield differentials. It is still rewarding from a yield differential perspective to short the yen,” he added.

According to Lambregts, by Dec 2007 the yen is expected to trade close to 113 levels and the sell-off in Asian currencies will be arrested as soon as some calm is seen. He added that 114.5 and 109 levels are crucial break out levels.

Sundeep Bhandari of Standard Chartered Bank said the unwinding in the yen carry trade is likely to continue. “From the markets perspective it appears that the market is saying buy yen at any price, and that is an exaggeration. But just to give you a sense that the market is sort of very bullish on the yen. What has happened is that there has been an increased risk aversion that has taken place, as has the sub-prime impact. We haven’t yet got a feel how it might, but we have seen a large amount of yen carry trade unwind,” he added.

Martin Baccardax, News Editor, CNBC Europe, said the yen has had a significant improvement overnight as investors take risky carry trade positions, often buying into the safe havens of the dollar.