Japan as the first stock exchange – then the rest of the world: It was not just since “Black Monday” that there has been great unrest on the stock exchanges. The Japanese yen plays an important role in this, as its years of weakness have lured investors worldwide into risky yen loans, a significant portion of which have been invested in stocks. That has now radically changed.
For three years, it seemed like a sure-fire bet: Take out a yen loan at extremely low interest rates of around zero percent and exchange the money for currencies with higher expected returns. Such yen carry trades, a type of interest rate differential trade, became increasingly popular from 2021 onwards and fed purchases of tech stocks and other risk assets such as Bitcoin on a large scale. Estimates of the growth of speculative yen carry trades in the last three years vary from several hundred billion dollars to over a trillion dollars. In any case, the chief currency strategist of the major bank Societe Generale, Kit Juckes, describes the Yen-Carry Trade as “the largest carry trade the world has ever seen”.
Interest rate turnaround in Japan stops massive yen devaluation
While the Bank of Japan – Japan’s central bank – has stubbornly maintained its negative interest rate policy in recent years, interest rates in most other regions have risen sharply due to galloping inflation. Loans at virtually zero interest rates were almost exclusively available in yen. Since interest rate differences have a decisive influence on the development of the exchange rate, borrowers also bet that the yen would depreciate against the dollar due to the conflicting interest rate expectations, thus making loan repayment cheaper. And that’s exactly what happened. The yen fell and fell. A first cautious interest rate hike by the Bank of Japan at the end of March 2024 to 0.0 to 0.1% did little to change the nosedive, as did support purchases by the Tokyo monetary authorities. The dollar climbed to a 38-year high of just under 162 yen by July 11. At the turn of the year it was still at around 140 yen.
It was only when rumors of a new interest rate hike and a general reversal in Japanese monetary policy emerged that the yen began to rise. And when the central bank actually raised the key interest rate to 0.25% on July 31 and also announced a gradual halving of its enormous monthly bond purchases – in other words a withdrawal of liquidity – it rose sharply. The dollar plummeted to around 143 yen – a loss of over 11% within three weeks. Investors who had taken on debt in yen at the beginning of July or earlier were left with high currency losses. Since the investment target of stocks also began to weaken, many of these speculative investors quickly ran for the exits, i.e. they were forced to buy back yen in order to repay the loans. This was because the lenders were demanding additional collateral.
Weak economic situation in the US and Europe raises high interest rate cut expectations
Unfortunately, the turnaround in monetary policy in Japan coincided with disappointing economic data from the US and Europe. This increased expectations that the Fed and other central banks would cut interest rates more sharply and more quickly from September than had been expected until recently. The interest rate differential between the dollar and the yen would thus shrink further and reduce the benefits of a carry trade. This is why the stock markets reacted so violently. Especially for assets whose prices had previously been cheap yen loans had risen particularly sharply, there were massive distress sales by hedge funds, currency traders and other large investors. American AI stocks such as Nvidia, cryptocurrencies such as Bitcoin and even real estate suffered from the waves of selling. And the Tokyo Stock Exchange collapsed by over 12% on Black Monday because many Japanese private individuals had taken out yen loans and speculated in domestic and foreign stocks – and now also pulled the ripcord.
Speculation with yen carry trades continues to cause nervous markets
Although there has been a recent price recovery, experts do not agree whether the worst is over or whether further trouble is looming. Morgan Stanley In any case, it is assumed that only half of the speculative yen carry trades have been resolved and that there will continue to be great nervousness. Especially since the yen is still considered to be heavily undervalued despite the steep rise in recent weeks. former ECB President Jean Claude Trichet recently described the yen’s rise as overdue and saw scope for further appreciation. Fire sales could therefore continue to weigh on the markets. The developments that investors should therefore monitor include not only whether the economy continues to slide, whether geopolitical risks continue to increase and whether the American and European central banks increase the pace of interest rate cuts. The actions of the Bank of Japan and the yen’s price trend are also part of the stock market’s mandatory program.
