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📉 Monday Market Crash: What Happened?

Understanding The Yen Carry Trade

Author

Madhu, Altcase
August 08, 2024

Welcome to this week’s Altsights!

Stock prices all around the world crashed on Monday 🔻

While the NIFTY 50 saw a relatively modest fall of ~2.7%, the Japanese Nikkei 225 crashed by over 12%.

The South Korean index KOSPI crashed by almost 9% whereas the US tech index NASDAQ fell by 3% after being down more than 6% intra-day.

Many factors converged and contributed to the brutal Monday market sell-off:

  1. Goldman Sachs raised the probability of a recession in the US from 15% to 25% after a weak employment report

  2. Warren Buffet sold 50% of his Apple stake and increased his cash pile to ~$275 billion

  3. Tension between Iran and Israel rose after Iran said it would ‘punish’ Israel for killing a Hamas leader on Iranian soil

  4. Japan’s central bank hiked interest rates for the second time in the last 17 years - the first time was in March 2024.

The rate hike in Japan took the interest rate to its highest level of 0.25% in the last 15 years. This has global implications as it may lead to the death of the Yen Carry Trade - our topic of discussion today.

What is The Yen Carry Trade 💹

All investment strategies are based on one principle - Buy low, sell high.

The Yen Carry Trade is no different!

Looks easy, doesn't it?

To be honest, this was quite easy for many years while the Central Bank of Japan kept interest rates close to 0% and Yen was weak/stable.

However, the most recent interest rate hike led to the unwinding of the Yen carry trade.

The Unwinding of the Yen Carry Trade 💹

What we saw on Monday was the ‘unwinding’ of the carry trade.

Because the Bank of Japan hiked interest rates carry traders sold their assets in India, Mexico, Brazil, the US etc. and converted them back into Yen.

This led to an increase in demand for the Yen which increased its price against all other currencies. So the ‘cheap’ Yen wasn’t cheap anymore.

This started a cycle where more carry traders sold off their assets to protect their gains/minimise their losses as Yen started to appreciate quickly.

How Appreciation in Yen Impacts the Yen Carry Trade 📈

Consider a trader who borrowed 140 Yen at a 0% interest rate and converted it into US dollars at an exchange rate of 140 and now has $1.

Suppose they invest it in a US corporate bond where the yield is 5%. So, this person will make 5% on their Yen if the exchange rate is stable.

However, if the Yen becomes more expensive and rises by 5% to 133 when they convert the dollars back to Yen, they will make no profit.

On the other hand, if the Yen becomes cheaper and falls by 5% to 147 when they convert the dollars back to Yen, they will make a 10% profit - 5% from the bond and 5% from the fall in Yen against the dollar.

The Future of the Yen Carry Trade 🔮

For over 15 years, super low interest rates in Japan and a weak Yen made the carry trade possible.

However, as both of these conditions cannot be taken for granted anymore, the Yen Carry Trade may not continue to be as viable as it has been.

While the Yen Carry Trade is not completely dead either, it will die a slow death if Japan continues to hike interest rates.

You see as Japan hikes interest rates, Yen becomes more expensive and Japanese bonds become more attractive. This makes the carry trade moot.

A Ray of Hope ☀️

Sensing that the rate hike created volatility not only in Japan but also globally, the Bank of Japan may not continue raising interest rates.

Even the Bank’s Deputy Governor played down the prospects of future interest rate hikes amidst an unstable market in his speech to Japanese business leaders yesterday.

Cheers,
Madhu,
Founder, Altcase