What is Yen carry trade? Why did it trigger a global stock market fall?

By Team Asianet Newsable | First Published Aug 7, 2024, 11:21 AM IST

The unwinding of the yen carry trade was one reason behind the fall in global markets on Monday. It had to do with recent policy decisions from Japan's central bank, which led global investors to sell their assets. Here is why.

Major global stock indexes saw their worst loss in decades earlier this week. There were many reasons to be nervous among investors, such as the likelihood of a recession in the US economy or the escalating geopolitical tensions brought on by the unrest in West Asia, but there was also a new global catalyst: the end of the yen carry trade. International investors are always searching for methods to increase their wealth. One method to do this is to take out a loan in a nation with low interest rates and invest the money in a nation with substantially higher interest rates (after converting the money). This type of trading is known as a carry.

The Bank of Japan's recent decision to raise interest rates to 0.25% and reduce bond purchases caused the yen to surge over 11% against the dollar. This unexpected move led to a rapid unwinding of yen carry trades as investors sought to avoid losses from a strengthening yen.

What is Yen carry trade?

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These kinds of chances arise from the fact that central banks throughout the world work to maintain interest rates at a level that is appropriate for their particular economic circumstances. One example is Japan, where the Bank of Japan, the country's central bank, maintained interest rates at zero percent from 2011 to 2016 and, since then, has actually lowered them to below zero (-0.10%). The idea behind low interest rates is to stimulate economic activity.

However, a "cheap money" monetary strategy like this has an impact on the entire world, particularly since Japan has the third-largest economy and the yen, its currency, is reliable. For example, these low interest rates encourage investors to borrow money in yen at a low cost and invest abroad (in the US, Brazil, Mexico, India, and even elsewhere) in the hopes of earning higher returns. We refer to these carry trades as "yen carry trades."

The Bank of Japan's prolonged policy of low interest rates encouraged billions of dollars in "yen" carry trades, which in turn fuelled investments in numerous countries worldwide. This policy persisted even after central banks worldwide swiftly raised interest rates in the aftermath of the Russia-Ukraine war.

The unwinding of yen carry trades has led to significant market volatility, reminiscent of the 2008 crisis but with different nuances. While the 2008 unwinding was dramatic and anticipated, the current situation is marked by heightened uncertainty and geopolitical tensions.

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