Is the Yen Carry Trade Unwinding? Here's a deep dive into how this could impact your portfolio
The increase in stock market volatility has dominated financial media coverage, and rightly so. But there's another important global asset also experiencing a surge in volatility: the Japanese yen $JPY. Let's dive into what's happening
Over the past month, the $JPY has rallied about 5%, moving from a low of 162ish- 154. This rise is largely due to the Bank of Japan (BOJ) intervening in the markets, either explicitly or implicitly, by buying yen to support its value. https://x.com/kurtsaltrichter/status/1816848458726215903
BOJ Intervention Practically, BOJ intervention means they are buying $JPY in the open market, which increases its value. Now, let's explore how this impacts the markets, especially if the yen carry trade is starting to reverse.
What is the Yen Carry Trade? The yen carry trade involves selling short Japanese government bonds $JGB and using the proceeds to buy risk assets like stocks, emerging market debt, commodities, crypto, and even U.S. corporate and government bonds. This trade has been popular for over two decades due to BOJ's low interest rates.
How the Trade Works
Imagine you're a big investment fund. You sell the 10-year JGB. You don't have any 10-year JGBs so you borrow them to deliver...
Your cost on the borrow (more or less) is to pay the yield (currently 1.08%, controlled by the BOJ so you don't have to worry about the bond moving too much.
You then use the proceeds to buy assets. If the cost of borrowing is only 1%, any gain above that is profit, ignoring currency movements
Risk Averse Strategy
If you're risk averse, you might sell short JGBs at 1.08% interest and buy U.S. Treasuries yielding 4.20%, making a 3.20% spread. As long as the $JPY doesn't strengthen more than 3% vs. the dollar, you're in the clear.
Funding Bull Markets
The yen carry trade $JPY has funded bull markets in virtually every asset class over the years, and for leveraged funds, it's been great for returns. However, there's always the risk of this trade unwinding..
Yen Carry Trade Unwinding Risk
An unwind happens if the yen rallies significantly. Leveraged trades don't need a big move to be pressured. If prolonged, like in 2006/2007, an unwind can lead to painful declines in stocks, bonds, commodities, and cryptos. https://x.com/kurtsaltrichter/status/1816848495308886240
Back to the present: Is the Yen Carry Trade unwinding?
Is the yen carry trade unwinding? Not yet, but it's something to watch. The yen has strengthened over 5% vs. the dollar in a month. Most of this is due to BOJ intervention, but it's likely impacting risk assets mildly.
Potential Yen Carry Trade Unwinding Triggers Looking ahead, several candidates could trigger a more intense unwind of the yen carry trade $JPY, adding pressure to risk assets. Let's dive in...
Fed's Dovish Stance First, if the Fed becomes more dovish than expected. The carry trade has thrived this year due to the dollar strengthening against the yen, driven by the policy gap between the Fed (no rate cuts) and the BOJ (very dovish)...
A dovish Fed could strengthen the yen and trigger an unwind. I.e. If the Fed comes out of left field and cuts rates in July/August that would immediately trigger an unwind of the yen carry trade.
U.S. Fiscal Concerns
Second, it's an election year. If markets worry about the U.S. fiscal trajectory (regardless of who is POTUS), JGBs would rally, and the dollar would decline, causing an unwind of the yen carry trade.
BOJ's Surprise Move
Finally, if the BOJ becomes more hawkish unexpectedly, the yen would likely strengthen, triggering an unwind of the yen carry trade
Technical Levels on the Charts
The 200DMA for the yen is around 151.60. The yen closed yesterday just under 154. Breaking this 200DMA could trigger a partial unwind and increase market volatility. I've set alerts on this level, and if it breaks, you'll know. https://x.com/kurtsaltrichter/status/1816848525264666756
