Wall Street is growing increasingly concerned about the "yen carry trade" and its potential to cause instability in US markets. This trade involves borrowing yen at minimal interest rates and converting them to dollars to invest in assets with higher returns, like US stocks and bonds, which has historically boosted US market liquidity and asset prices. However, a confluence of factors, including the yen hitting a 40-year low against the dollar (around 162 yen per dollar), rising inflation in Japan, and the possibility of the Bank of Japan or the government intervening to strengthen the yen, could disrupt this trade. Such a disruption could range from a minor market blip to a more dramatic decline, depending on the extent of the unwind.
Investors are particularly worried that Japanese intervention to prop up the currency, especially if it breaks the critical 160-yen-to-dollar level, could significantly impact profits from the carry trade. Analysts from Morgan Stanley suggest that the Bank of Japan may buy more yen to boost its value. Additionally, a hawkish shift in Japanese monetary policy, driven by increasing inflation, could lead to higher Japanese interest rates, making the carry trade less attractive and prompting investors to sell dollar assets to cover rising borrowing costs. The Bank of Japan's August 2024 surprise rate hike already triggered a sharp drop in US stocks and the worst day for Japanese stocks since 1987.
The potential unwinding of the yen carry trade is viewed by some as an under-appreciated risk with significant implications for global liquidity and asset prices, including the US equity market. Mark Malek of Siebert Financial emphasized that changes in Japanese monetary policy could become crucial drivers of US asset prices. SocGen's Albert Edwards warned of a potential "slow-motion currency crisis" and questioned whether the US equity market could sustain its current valuations if Japanese bond yields converge with higher US rates. Concerns about Japan's fiscal health are also pushing Japanese bond yields higher, with 10-year government bond yields up 150 basis points in the past year, further complicating the outlook for the carry trade.
While some sources discuss a broader resurgence of carry trades across G10 currencies due to low volatility and wide interest rate differentials, the specific focus in this context remains on the yen carry trade as a source of potential market volatility. Previous interventions by Japan's Finance Minister to address yen volatility also caused a slight unwind of the trade as investors anticipated a stronger yen. The consensus among many analysts is that an "unruly unwind" could lead to "widespread damage" in global markets.
