The yen carry trade, a popular strategy where investors borrow yen at Japan’s low interest rates to invest in higher-yielding assets, may once again be influencing global markets.
Despite imminent rate cuts in the US, the S&P 500 dropped 4.3% last week, leading many analysts to speculate that the unwinding of the yen carry trade is not yet over.
As the Federal Reserve debates further rate reductions, the impact of Japan’s monetary policy on global financial markets remains a key focus for investors.
Japan’s interest rate hike shocks markets
n a surprising move, Japan recently raised its interest rates, which triggered a sell-off in global stocks.
Investors scrambled to unwind their carry trades, selling off assets purchased with borrowed yen, causing markets to slump.
This largely unexpected rate hike highlighted the fragility of the global financial system when it comes to Japan’s historically low interest rates.
Bank of Japan (BoJ) Governor Kanuo Ueda added fuel to the fire when he hinted at further rate hikes in the future.
During a parliamentary hearing two weeks ago, Ueda stated that Japan’s short-term rates are still very low and could rise if the economy remains strong.
This statement has heightened concerns that more disruptions may be on the horizon as the BoJ shifts toward tighter monetary policy.
Experts warn of further turbulence
JPMorgan was among the first to predict that Japan’s rate hikes would lead to significant market volatility.
The bank warned that the August sell-off, sparked by Japan’s initial rate increase, was just the beginning.
This view appears to be playing out, with last week’s developments in both Japan and the U.S. suggesting further unwinding of the carry trade is likely.
Ed Yardeni, president of Yardeni Research, believes that the yen carry trade will continue to unwind, especially if the US implements a 0.5% interest rate cut soon. While last week’s employment data showed signs of weakness, Yardeni noted that this may lead to unexpected short-term growth, providing a temporary boost to markets.
However, Yardeni is clear in his assessment: the ongoing market slump is primarily a result of the yen carry trade still unwinding.
As investors unwind their positions, selling off assets financed with yen, global markets are feeling the pressure.
‘Risk-off’ mood to drive further unwinding of carry trades
Kathy Lien, managing director at BK Asset Management, holds a more pessimistic view.
She argues that the current “risk-off” mood across financial markets will drive further unwinding of carry trades, especially as investors brace for more economic uncertainty.
Lien’s outlook is particularly bleak for the stock market in the coming months, as the unwind of carry trades could exacerbate existing market volatility.
The Japanese yen has long been the currency of choice for carry trades, given Japan’s low interest rates.
As the BoJ begins raising rates, the repercussions could be far-reaching. Some experts warn that the monetary damage from an ongoing unwind of the yen carry trade could be immense, potentially running into trillions of dollars in losses.
With less than two months until the US elections, investors are particularly wary of market disruptions.
The intersection of Japan’s evolving monetary policy and US political uncertainty has left global financial markets on edge.
While some analysts hold out hope that forthcoming rate cuts in the US could stabilize markets, the lingering threat of the yen carry trade unwinding remains a key concern.
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