The Global ‘Carry Trade’ is Unwinding, Leaving Broken Markets in its Wake

For the past 15 years, Japan maintained its interest rates at or near 0%. This prolonged period of exceptionally low rates led investors to borrow trillions of yen, and invest these funds in stronger currencies and assets. 

This strategy, known as the “yen carry trade,” essentially constituted a bet that the yen would continue to depreciate in relative value. The strategy proved highly effective until last Wednesday.

In a notable shift, Japan’s central bank raised its interest rates slightly to 0.25%. While this rate remains remarkably low, it triggered a significant appreciation of the yen, which surged by 7.5% against the US dollar. This sudden spike in the yen’s value forced investors to cover their short positions, resulting in enormous losses totaling billions of dollars. This chain of events precipitated a substantial global sell-off as investors sought liquidity by offloading other performing assets.

The end of the yen carry trade this week has had far-reaching consequences for global markets. Many investors might be perplexed by the sudden downturn in their portfolios, and this development largely explains the recent turbulence.

An additional bearish factor contributing to this situation, which has not been widely discussed, is Japan’s reliance on oil imports. Japan produces approximately 2 million barrels of oil per day but consumes double that amount or more, necessitating substantial oil imports.

Current geopolitical tensions are exacerbating an already volatile oil import market. Iran has threatened a significant strike against Israel in response to a surprise attack on Tehran last week. This retaliatory strike is anticipated imminently, possibly even today. If such an event unfolds, it could prompt Israel and the United States to take military action against Iran. In retaliation, Iran might close the Strait of Hormuz, a critical choke point through which 20 million barrels of oil pass daily.

The closure of the Strait of Hormuz would cause a dramatic increase in global oil prices, severely impacting Japan’s economy due to its heavy reliance on oil imports.

In summary, these interlinked developments underscore the precariousness of the global economic situation. The sudden end of the yen carry trade and the potential for escalated conflict in the Middle East are formidable challenges. It is crucial for all parties involved to exercise restraint and seek diplomatic solutions to avoid a broader conflict with Iran, as the stability of the global economy likely hinges on such efforts.