QTR’s Fringe Finance: George Gammon Explains the Yen Carry Trade Chaos
The market’s slump over the past two weeks has largely been driven by traders exiting the yen carry trade. Simply put, traders sell short the Japanese yen. They do this because the yen has historically had a zero or near-zero yield.
They then take the money and invest it in higher-earning assets. That could include the U.S. dollar, where cash yields currently sit near 4%. Some more aggressive traders could even use that money to invest in a market index.
However, last week the Bank of Japan raised interest rates to help curb inflation. While rates are still ultra-low in Japan, the quarter-point hike represented a big shift higher. That made the costs of undertaking the carry trade significantly more expensive.
As a result, traders have had to deleverage trades. This has not been an orderly process. It’s meant selling stocks to raise cash, to buy yen and close that short position. Selling pressures resulted in a big move down for markets in a matter of days.
Taking those positions down quickly will likely result in many losses for traders. But it could also avoid a further selloff and the danger of margin calls. Market volatility may have peaked for this year, but investors could still see some big market swings in the weeks ahead.