As shown below, the Japanese yen has fallen to levels not seen since the late 1980s. (Note the chart quotes , thus a higher figure represents a depreciating yen) We have written extensively about why the yen matters to US markets: the yen carry trade. The trade is relatively simple.
An investor borrows yen at low interest rates in Japan, converts the proceeds to dollars, and buys higher-yielding US assets, typically stocks or bonds. As we wrote in 2022, putting down $100,000 to borrow $1,000,000 in yen and buying a 3% Treasury note can generate nearly a 30% return, assuming the yen’s value doesn’t change versus the dollar. The success of the trade depends almost entirely on a weak or stable yen.
The risk in a carry trade arises when the currency appreciates against the dollar. Given that the carry trades are estimated at $10 to $20 trillion in aggregate, a forced unwind can have global impacts. We saw this play out in August 2024, when Japanese currency intervention spurred a rapid strengthening of the yen, triggering a 10% decline in the S&P 500 in a matter of days.
Today, the yen is weakening. This keeps the carry trade economically attractive rather than under stress. But Bank of Japan officials are increasingly discussing its weak currency as a source of domestic inflation, since Japan imports nearly 100% of its energy needs. Prolonged weakness sets up the conditions for the next reversal whenever the BOJ decides to stop it.
In a section below, we detail what this condition implies for markets and provide links to prior pieces on the yen carry trade and Japan.
A Yen Carry Trade Unwind
As we lead, the carry trade thrives with a weak yen, as we have today. Despite higher Japanese borrowing costs, the yen has depreciated significantly against the dollar, more than offsetting the higher interest costs for carry trades. A weakening yen means the trade remains profitable, and the leverage the carry trade provides to markets continues to build.
The likely catalyst for change is the Bank of Japan (BOJ). BOJ officials are concerned that prolonged yen weakness is inflationary as it raises import costs. If currency-driven inflation intensifies and public pressure mounts, the depreciating yen could force the BOJ to pursue additional rate hikes to strengthen the currency. Additionally, the BOJ could intervene in the currency markets to support the yen.
That is the mechanism that was triggered in 2024. On July 11th, the BOJ intervened in currency markets. The got hammered while the surged. Given that the Nasdaq was the likely home for much of the yen carry-trade investment, the market divergences were a clear sign of carry-trade unwinding.
The risk today to US investors is that higher Japanese yields and a stronger yen could force a rapid, disorderly reversal of the carry trade. Bear in mind that the more the yen falls, the more the trade grows, and the larger the unwind will be whenever the BOJ finally acts. Below, we share articles we have written on the topic:
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