The answer to this question is the Yen carry trade, a term you’ll probably hear many times this week. So what exactly is the Yen carry trade and why did it cause a market downturn?
It all started after the Bank of Japan (BOJ) decided to raise rates at their most recent meeting. The BOJ raised rates to ~0.25% in their second rate hike since 2007, effectively ending the negative rate policy. For years, traders took advantage of these ultra-low rates.
The Yen Carry trade explained: For years, investors would borrow Yen at ultra-low rates, such as ~0.4%, and use this 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. Many traders were borrowing Jap Yen (JPY) at low interest rates, converted them to USD, and used this to buy US stocks.
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, 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. But here’s why this is the key point: As the Yen strengthens, many of these Yen carry trades are being “margin called.” Now that the Bank of Japan (BOJ) is raising interest rates, the JPY has strengthened significantly against the USD. Now, these traders are in big shit. Not only must they pay higher interest for the JPY they borrowed, they are now facing huge forex (The foreign exchange market) losses as well. 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.
This is causing a huge unwind of these trade positions. Traders facing big losses and margin calls are selling their US stocks to raise USD, converting back to JPY and paying back their loans
The solution to this problem is not as simple as it may seem and may require a separate article. This is a vastly different situation than previous market downturns. For now, we are trading the volatility.
This can lead to more selling pressure on US stocks and even more declines in the short term. Middle East war escalation, and US political uncertainty is also adding to the fear and panic. As an investor, this is great news because this type of short-term crisis and panic is what gives you the opportunity to scoop up high-quality US stocks at bigger and bigger discounts.
The Magnificent 7 are down over a trillion:
- NVDA down $325 billion
- AAPL down $300 billion
- GOOGL down $200 billion
- AMZN down $135 billion
- MSFT down $125 billion
- META down $80 billion
- TSLA down $60 billion
Current situation:
- Stocks are falling like we are entering a global recession
- Gold prices are falling like there’s no volatility at all
- The $VIX ( the volatility index) is rising like markets are in 2020 and 2008 conditions
- Oil prices are falling like demand is about to collapse
- Treasury yields are falling like rate cuts are on the way
- Tech stocks are falling like the AI bubble has burst This is a massive run to the sidelines.
