The short yen thesis based on the resurgence of the G10 carry trade is not valid, according to Adam Cole of RBC Capital Markets.

The thesis goes something like this: the carry trade is back because G10 central banks are starting to raise interest rates; the yen will be the main funding currency of the carry trade and will therefore fall.

Cole, however, disagrees.

He said the carry trade, in its purest form, isn't back. Absolute interest rate differentials are still small, so traders aren't broadly buying high-yielding currencies and selling the yen. Instead, changes in interest rates have driven the forex market.

Looking ahead, this leaves the Australian dollar and the New Zealand dollar vulnerable because although their interest rates are the highest among G10 currencies, their central banks have paused rate hikes.

It also means that the overly-bearish forecasts on the Japanese yen are wrong because it will likely not suffer big declines against currencies with unchanged interest rates. Against the US dollar, for example, the yen's rate dynamics are "at worst, neutral" because the Federal Reserve will not raise interest rates any time soon, said Cole.

Below are two charts that illustrate Cole's point. The first shows the performance of currencies vs. absolute yields and the second shows the performance of currencies vs. changes in yields.

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