Analysis
How Japan’s Yen Carry Trade Crashed Global Markets
An obscure strategy wreaked short-lived havoc.
By
William Sposato, a Tokyo-based journalist.
A man looks at an electronic quotation board displaying Nikkei 225 stock prices on the Tokyo Stock Exchange.
A man looks at an electronic quotation board displaying Nikkei 225 stock prices on the Tokyo Stock Exchange in Tokyo on Aug. 6. Kazuhiro Nogi/AFP via Getty Images
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August 8, 2024, 1:47 PM
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The global mini-crash on Monday, when stocks dived before
largely recovering, can’t be pinned down to one cause alone. But one serious culprit was a long-standing foreign exchange strategy that suddenly turned into a disaster as Japan’s central bank and government tried to pull the yen out of an increasingly destructive nosedive.
The “yen carry trade” is a straightforward maneuver: borrow money in a country with low interest rates, such as Japan (or Switzerland), and invest in currencies with a higher interest rate, such as the U.S. dollar. If all goes well, the result is a cost-free source of profit.
Not surprisingly, this has become very popular with financial traders, businesses, and even individuals who have used the technique to pay for mortgages in their home countries.
At current levels, an investor can borrow yen for around 0.5 percent and find a secure U.S. investment at around 5.5 percent. This means a 4 percent gain with no investment of your own.
The only potential problem is if the exchange rate between the two countries starts to change. In this case, a stronger yen means that you will need more dollars to pay back the loan, potentially wiping out the gain and leaving expanding losses.
“These violent market moves will take place when participants in the ‘crowded trade,’ in this case yen carry, all try to get out of the pool at the same time. Moves on the downside can be swift and violent and at times can lead to changes in market psychology,” said Ichiro Sekimitsu, a former veteran trader in interest rate derivatives.
“A necessary condition for the trade to continue is low volatility, so the predictability of the Bank of Japan and the Japanese Ministry of Finance, along with an underperformance of the Japanese economy, probably helped build the trade.”
All of this came unstuck on Monday as a fast-rising yen fed into a declining stock market, which in turn sparked a greater unwinding of what are known as “
yen shorts”—bets that the yen will further decline.
That sent the yen sharply higher in value as traders quickly closed out their positions. In mid-July, the dollar was worth more than 161 yen, but by the end of the Asian trading day on Monday, it stood at 142 yen, a 12 percent fall in value.
That would easily wipe out a year’s worth of yen carry trade interest payments. Small wonder that there was an increasingly hectic race for the exits.
