startling rise of the Japanese yen against the dollar.
Bankers and analysts attribute the good news to caution by the banks after disastrous trading results in last year's third quarter, when markets were roiled by Russia's default on its bonds and problems in other emerging-market countries.
As part of their ordinary business, big banks and securities firms seek to take advantage of differences in interest rates from one country to another. Japan has been a favorite venue for such business, because the yield on 10-year government bonds is only 1.7%, compared with 6% on similar U.S. securities. These deals are called carry trades.
An investor could earn a high return by selling yen for dollars and investing the dollars in the higher-yielding U.S. securities. And an investor, such as a bank, easily could borrow yen at the lower rate and invest it in the United States at the higher rate.
But it is a gamble. The wild card is the exchange rate. If the dollar/yen rate remains unchanged, the investor ends up with the higher return. But if the yen were to move sharply higher in relation to the U.S. currency, the losses could be severe, because the dollar would buy far fewer yen.
And the dollar has plunged versus the yen, by 9% since mid-August and 28% over the past 14 months.
The scenario could have been devastating for the world's trading banks, but currency specialists say that many saw the problems coming and unwound many of their arbitrage positions. As a result, the rise of the Japanese yen is unlikely to cause much fallout among banks with international trading operations, observers say.
It was not only the early unwinding of arbitrage positions that kept banks from being badly wounded, but also conservatism after last year's third-quarter debacle, when banks lost millions on emerging-market securities.
Last year trading casualties were heavy. Bank of America Corp. lost $330 million; the former Bankers Trust New York Corp. -- later bought by Deutsche Bank -- lost $350 million. Long Term Capital Management, the Greenwich, Conn., hedge fund, with about $100 billion in assets, was brought to near collapse and needed a bank bailout to keep it afloat.
With big banks and hedge funds being burned last year, the majority of foreign currency speculation has been left to smaller boutiques with a penchant for risk, said Sung Won Sohn, senior vice president and chief economist at Wells Fargo & Co. in Minneapolis.
"This year, with the falling dollar, the financial cowboys have shed a lot of blood on the floor," Mr. Sohn said.
Banks "have reduced their positions globally," said William Dudley, director of U.S. economic research for Goldman, Sachs & Co. With the dollar falling from a high of 147.26 yen last year to 106.19 Tuesday, "you have washed out of lot of people in that trade."
The unwinding of the carry positions itself has been a factor in the yen's rise, said Alex Blinkhorn, chief currency trader at Bank of Tokyo-Mitsubishi in Duesseldorf, Germany. "What we have seen in the last few months in the face of the yen's upward trend is mostly closing out old positions rather than opening new positions."
For banks whose trading desks already have large credit lines, jumping back into carry trades would be easy. But smaller gamblers will be hard-pressed to find willing lenders of yen, given the efforts of Japanese banks to clean up their balance sheets, Mr. Sohn said.