Yen Carry Trade: Why Did Global Markets Crash? | Stock Market News | News9

Markets across the world are experiencing high volatility… From Japan’s Nikkei to the US’s Nasdaq and pretty much every other index in between, a massive sell off was witnessed for three trading sessions. Why? Let’s understand. Bank of Japan – Japan’s central bank raised interest rates to 0.25% on 31st July. Remember, this is only the second rate-hike since 2008. And doing so has affected one of the most popular investment strategies in the world – called the Carry Trade. Ok – so what exactly is Carry Trade? Simply put, an investor first borrows money from a country with low interest rates and a weak currency – say Japan – and then converts the borrowed Yen into US dollars. These dollars are then invested in either stock markets or US bonds to churn up a high return. Now since Japan had a near-zero interest rate since 2008, investors saw it as the ideal source of borrowing money. But then, BOJ upped interest rates. So, what happened then was an appreciation of 2% in the Japanese Yen against the US dollar. This means that anyone who borrowed X amount of money from Japan will now have to return 2% more! So, a billion dollars’ worth Yen borrowed from Japan will mean another 20 million will have to be returned to Japan – plus now an increased cost of capital by 0.25% - the new interest rate. Some estimates suggest that the Yen Carry Trade runs in a few trillion dollars! And some these investors are trying to sell their investments pre-maturely just to pay back their borrowings in Japan, which just got more expensive. As a result – a selling pressure that dragged global markets down. What happens next? Well – Japan’s stock markets are considered by many analysts as a bellwether of the global economy. Volatility in Japan suggests that globally too, volatility will sustain. Adding to the doomsday prophecy is the fear of the US slipping into recession after the latest jobs report showed unemployment rate climb to 4.3%. The stress in the conflict zones in the middle east are also likely to keep the uncertainty in the stock markets to keep ticking.

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