On August 5th 2024 , markets around the world faced a mini Tsunami . Stock markets tanked around the world. Japan’s Nikkei dropped 12.4%, Dow Jones dropped 1.01% and S&P 500 -1.73%. At the heart of this massive drop was Yen Carry Trade. What is Yen Carry Trade and can this be cause a potential Recession?.
Yen Carry Trade arises out of interest rate differentials around the world. Past few years Japanese Yen as been investor’s preferred instrument for borrowing money at a low interest and investing in other economies around the world where interest rates are high. Japanese Central Bank has maintained ultra low interest rates for years compared to other central banks around the world that started raising rates to counter rising inflation. Hedge Funds and other financial institutions recognized this opportunity and started borrowing yen and invested that money in stock markets around the world.
| Date | Rate |
|---|---|
| Jan 31,2021 | -0.1 |
| Jan 31,2022 | -0.1 |
| Jan 31,2023 | -0.1 |
| Jan 31,2024 | -0.1 |
| Feb 29,2024 | 0.10 |
| Jun 30,2024 | 0.25 |
The Yen carry trade worked really well for investors for a few years where rates remained low for Japanese Yen and market volatility was relatively low. However investors were spooked when BOJ started hiking interest rates, they were hit by margin calls from their brokers due to rising Yen prices. Adding fuel to this fear was market instability, which likely created the drop in US Markets on 5th August 2024.
Since August 5th drop, BOJ (Bank Of Japan) policy maker has confirmed that any further rate hikes would take into account the prevailing Market conditions. Investors around the world are hoping to put the incident in the rear view mirror, however is Carry Trade Fiasco over yet? Can it create jitters around global markets again?
According to an article published by WSJ, Japanese banks’ foreign landing increase to $1 Trillion as of March 2024 , a 21% increase from 2021 levels. Further surge in Yen prices could lead to financial institutions around the world scrambling to hedge their bets which could further push Yen prices higher. This cycle of hedging and price increase could potentially be dangerous.
What happens over next few months remains to be seen. Banks and other financial institutions around the world would be cautious and take measures to ensure this does not turn into a financial catastrophe.