The Yen Carry

Yen Carry... Wait What?

Imagine you’re at a poker table, and you notice that one player is betting with chips they borrowed from someone else. They’re using these borrowed chips to make high-stakes bets, hoping to win big with a good hand. The idea is to capitalize on the difference between the low cost of borrowing the chips and the high potential winnings. But if luck turns against them or the game gets too intense, they might end up in a tight spot, scrambling to cover their bets and return the borrowed chips.

Which leads us to the headlines today, "Global Market Rout" on just about every major market site such as CNBC. So if you had to guess what's driving global stocks to drop at such a rapid pace I imagine most casual investors would list things such as , war in the middle east, interest rates, elections and so on. The term Yen Carry probably wouldn't be on anyone's Bingo Card but it's leading to a correction that at the moment has been pretty extreme and in some places historical. Japan’s Nikkei Stock Average closed down 12.4% in its biggest single-day percentage fall since 1987. So what is the Yen Carry??

Japan and Low Rates

Japan's economic bubble burst in 1991, leading to a prolonged period of stagnation known as the "Lost Decade." In response to the economic crisis, the Bank of Japan (BoJ) began reducing interest rates to stimulate the economy. In 2001 The BoJ formally adopted a zero interest rate policy (ZIRP) to combat deflation and stimulate economic growth. Then in 2016 The BoJ introduced a negative interest rate policy, charging banks for holding excess reserves, aiming to further stimulate economic activity and combat persistent deflation.

For years, investors would borrow Yen at ultra low rates, such as ~0.4%, and use these Yen as a form of leverage. Investors could convert these Yen to US Dollars or other currencies and get almost free margin. Low rates made this possible. Hence the "The Yen Carry Trade".

The wide spread between rapidly rising rates in the US and other countries and negative rates in Japan made it possible. However, as the BOJ began raising rates (starting last week), this resulted in an unwinding of the carry trade. Especially as rate cuts are beginning in the US and EU.

As a result, the Japanese Yen strengthened and the USD/JPY currency pair just hit its lowest level since December 2023. You now receive 142 Yen for every US Dollar compared to 160 Yen for every US Dollar a few weeks ago.

So What's the Big Deal?

As the Yen strengthens, many of these Yen carry trades are being "margin called." Suddenly, the era of "free" Yen loans is coming to an end. As these margin loans are called, the underlying assets are being sold and crashing equity markets. The carry trade is unwinding. With this unwinding we are seeing massive volatility and selling.

So What Now?

These type of drawdowns are actually pretty common. In fact almost 94% of of years have at least 5% move back. Younger investors can take advantage of lower prices while older investors have an opportunity to rebalance. Bond Markets have actually been rallying into this weakness. As always we are here to help weather you are just starting to invest or nearing/ in retirement.

Contact us with questions or if we can help.

Sean Gray Principal and Founder