What is a ‘yen carry trade’ and how does it work?

Global stock markets have fallen sharply since August 5, resulting in large losses in major markets from Tokyo to London. Japan’s Nikkei suffered its largest daily decline since 1987, indicating a major systemic problem.

What happened on August 5, 2024?

On August 5, 2024, the markets declined sharply. Trading was suspended as the Nikkei declined 12.40% and the Topix declined 12.48%. Markets in Europe and India also fell, with India’s Sensex falling more than 2,200 points, wiping out nearly ₹15 trillion in wealth.

What caused the recession?

The main reason for the collapse of this market was the closure of the yen carry trade. This business strategy involves borrowing money in Japan, where interest rates are lower, and investing it in other countries of higher returns. When Japan began raising interest rates, the business became less profitable.

Why is the yen carry trade failing now?

The Bank of Japan raised interest rates to 0.25% and announced plans to scale back its bond-buying program, helping the yen strengthen against the U.S. dollar. The change made yen carry trades less attractive, causing investors to sell their positions faster.

Are there other contributing factors?

Other factors contributing to market volatility include fears of a potential U.S. recession, unemployment up 4.3% and concerns about geopolitical tensions, particularly a possible conflict involving Iran.

About the business of carrying yen

Yen carry trades involve borrowing Japanese yen at low interest rates and investing in higher-yielding assets. It became popular after the 1990s as Japan’s economic growth slowed. Traders take advantage of currency fluctuations to make money. However, this strategy is especially risky during periods of market volatility, as changes in currency values ​​can lead to substantial losses. The success of the yen carry trade is heavily influenced by the Bank of Japan’s monetary policy. It works best when global investors are willing to take the risk, often resulting in large capital flows into emerging markets.

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