As a market research and boutique financial consulting firm that guides institutional investors around the world, we have been receiving a lot of questions around the unwinding of the Japanese Yen carry trade and its influence on financial markets, and this blog post touches a little more on that.
It is important to understand that global financial markets and the market pricing of securities around the world are inextricably interconnected, as capital in principle flows from the lowest yielding securities to the highest yielding securities. Essentially, the carry trade is a strategy that involves borrowing in lower yielding funding currencies (e.g. Yen) and reinvesting the proceeds in higher yielding target currencies (e.g. US Dollar) to capture the spread.
The Yen has been a favorite funding currency for speculators and investors for over a decade primarily because of the Bank of Japan’s (BoJ) zero interest rate monetary policy and aggressive bond buying experiment (akin to quantitative easing) which was designed for artificially flooding the markets with monetary stimulus/liquidity to help reverse two decades of economic stagnation. To put into context the scale of the intervention, the BoJ (Japanese Central Bank) now owns more than half of all outstanding Japanese government bonds.
Recently the BoJ has hiked interest rates for the first time in years and declared that they will eventually sell their government bond holdings (similar to quantitative tightening) to allow financial markets to correctly set long-term interest rates on government bonds after a decade of manipulating and artificially depressing yields. The introduction of this somewhat shocking shift in monetary policy (bond yields rising from rock bottom levels) by the BoJ has spurred extreme volatility in longer-dated securities globally and triggered a repricing of the Yen by financial markets.
Another catalyst for the unwinding of the carry trade has emerged with global central banks coordinating and targeting a more dovish stance (cutting interest rates) on monetary policy in response to disinflation where market participants are now rushing to unwind/cover positions by selling holdings in target currencies (e.g. US Dollar) and buying back funding currencies (e.g. Yen) triggering an explosive rally in the Japanese yen.
As we navigate the potential for further tightening of artificial monetary stimulus by the BoJ and looser monetary policy by central banks around the world, we see the potential for further large-scale displacements in financial markets across the globe, and that’s where we help.
If you are a family office or institutional investor and have questions around the unwinding of the Yen carry trade and its impact on financial markets globally, let’s connect and explore what’s possible.