Yen yorker: What is the ’yen carry trade’ that’s causing a global stock rout?

Investors across the world witnessed a torrid start to the week as equity markets from Tokyo to London went into a tailspin. Mint looks at the reasons behind the global ‘stockocalypse’: 

What happened on Monday? 

Global markets were in a sea of red, led by Japan, where the benchmark Nikkei tumbled 12.40%, marking its largest one-day fall since ‘Black Monday’ in October 1987. The broader Topix index crashed 12.48%. Such was the intensity of the selloff that circuit breakers temporarily halted trading of futures for the Topix as well as the Nikkei 225. Trading was also suspended for the Kospi and Kosdaq cash and futures markets in South Korea. European markets too retreated under selling pressure. In India, the Sensex crashed over 2,200 points, wiping off ₹15 trillion in investors’ wealth.    

What caused the meltdown? 

Experts attribute this to the unwinding of the yen carry trade. A carry trade is a widely popular trading strategy in which an investor borrows from a country with low interest rates and a weaker currency and invests the money in the assets of a country with a higher rate of return. The yen is one of the most widely used currencies for this purpose as Japan has been maintaining a zero-interest rate regime for over two decades. The gush of funds from Japan has been a major source of liquidity for equity markets around the world.

Why is the yen carry trade unravelling now? 

Last week, the Bank of Japan raised interest rates for the second time this year to 0.25%, apart from announcing a bond tapering plan. Additionally, it left the door open for further rate hikes this year. This has led to the yen strengthening against the US dollar. A strong domestic currency coupled with rising interest rates in Japan is making the yen carry trade unprofitable for investors.

Are there any other reasons for the market meltdown? 

Global markets are also fretting over the US tipping into recession after its unemployment rate spiked to 4.3%, stoking fears that the Federal Reserve has fallen behind the curve in its policy support. However, this raises the chances of a Fed rate cut next month. Treasury bonds are seeing safe-haven demand, with US 10-year yields hitting 3.723%, the lowest since mid-2023. Geopolitical tensions have also ratcheted up over fears of Israel engaging in a multi-front war against Iran and its proxies. Any direct involvement of the US is also being keenly watched.

What does this mean for India?

Dalal Street can expect intense spells of volatility, in tandem with other major markets, in case of a prolonged unwinding of the yen carry trade. Japan is among the top 10 equity market investors in India. Assets under custody of Japanese foreign portfolio investors stood at ₹2.05 trillion at the end of June, as per data from India’s National Securities Depository Ltd. While the growing muscle of domestic institutional investors will ensure a cushion for the stock markets, a deepening global risk-off sentiment can be detrimental for liquidity. This can also put pressure on the rupee, which was the second-worst performing currency in Asia last month.