The carry trade strategy, whereby investors borrow Japanese yen to invest in assets with higher yields, could once again influence global markets.
The S&P 500 fell 4.3% in one week despite imminent US rate cuts, which led many analysts to speculate about the ongoing unwinding of yen carry trading.
Investors continue to be focused on the global impact of Japan’s monetary policies as the Federal Reserve considers further reductions in interest rates.
Japan’s rate hike shocks the markets
In a surprise move, Japan raised interest rates recently, triggering a global stock sell-off.
The markets plunged as investors scrambled unwinding their carry trades and selling assets bought with borrowed yen.
The unexpected rise in interest rates has highlighted the fragility and instability of the financial system globally, especially when Japan’s historically-low interest rates are considered.
Kanuo Ueda, Governor of the Bank of Japan (BoJ), added more fuel to the flames when he suggested that future rate increases would be forthcoming.
Ueda said that Japan’s rates for short-term loans are very low, and they could go up if the economic growth continues.
The BoJ’s shift to a tighter monetary regime has raised concerns about more disruptions.
Experts predict further turmoil
JPMorgan’s was one of the first banks to forecast that Japan’s interest rate increases would cause significant volatility in the market.
Bank of America warned that August’s sell-off was only the beginning. It had been triggered by Japan’s first rate hike.
The carry trade appears to have been unwound, as the developments last week in Japan and the U.S. suggest.
Ed Yardeni is the president of Yardeni Research and believes the carry trade in yen will continue, particularly if US interest rates are cut by 0.5% soon. Yardeni said that while last week’s jobs data indicated weakness, this could lead to an unexpected surge in short-term economic growth. This would provide a temporary boost for markets.
Yardeni’s assessment is that the current market downturn is due to the unwinding of the carry trade in yen.
Global markets feel the pressure as investors sell assets that were financed by yen.
Carry trades will be further de-risked by the ‘risk off’ attitude
Kathy Lien is the managing director of BK Asset management and she has a pessimistic outlook.
She believes that current market “risk off” sentiment will lead to further de-risking of carrytrades as investors prepare for economic uncertainties.
Lien’s outlook for the market is particularly grim in the months to come, because the unwinding of carry trades may exacerbate the existing volatility.
Carry trades have long used the Japanese Yen, due to Japan’s low rates of interest.
The BoJ’s decision to raise rates could have far-reaching consequences. Experts warn of massive monetary losses from a continuing unwinding of the carry trade in yen. Losses could reach trillions of US dollars.
Investors are especially wary about market volatility with less than two month until the US election.
Global financial markets are on edge due to the intersection between Japan’s changing monetary policy, and US political unrest.
Although some analysts are hopeful that upcoming rate cuts in the US will stabilize the markets, the threat of the carry trade unraveling is still a major concern.
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