[Insight & Opinion] Hoping for an Orderly Unwinding of the Yen Carry Trade

Early August Stock Market Crash Also Fueled by Japan’s Monetary Policy
Global Rate Cuts Now Unavoidable
Rapid Shifts Could Disrupt Financial Order

Global shipping company Maersk stated that there are no signs of a recession in the U.S. economy. Maersk expressed surprise at the resilience of container cargo volumes and expects this resilience to continue for the next few quarters. There is absolutely no indication that the global economy is heading toward a recession. The U.S. Bureau of Labor Statistics reported that the Consumer Price Index (CPI) in July rose 2.9% year-over-year, falling short of experts' forecast of 3.0%. A rate cut by the U.S. Federal Reserve in September seems certain. The stock market crash in early August was triggered by fears of a recession, but changes in Japan's monetary policy and the resulting overreaction in financial markets also played a role.

Because global financial markets are imperfect, carry trades occur. A representative example is the yen carry trade using the Japanese yen. Investors use yen carry trades based on the judgment that the risk of loss due to exchange rate differences between the yen and other currencies is low. At the end of April, the yen broke through the psychological resistance level of "1 dollar = 160 yen," falling to 162 yen in June?the lowest level in about 38 years. When the yen rose to the 140 yen range per dollar, financial markets recalled memories of yen carry trade liquidations. On July 31, the Bank of Japan raised its benchmark interest rate from 0?0.1% to 0.25% and left the door open for further hikes, causing Asian stock markets to plunge.

The Deputy Governor of the Bank of Japan stepped in to calm market anxiety. He stated that no further rate hikes would be made amid unstable financial capital markets. During the period of yen weakness starting in 2005, the Australian dollar and New Zealand dollar were popular. At that time, the benchmark interest rates in Australia and New Zealand were 6?7%, creating a wide interest rate gap with Japan’s zero rates. Japanese individual investors actively took advantage of this situation and competed to invest overseas. They exchanged yen for Australian and New Zealand dollars and began investing across borders. It is analyzed that their actions lowered the yen’s value by about 20 yen.

In 2007, the scale of yen carry trades reached a record high of 23.4 trillion yen. Speculative forces such as hedge funds are major players stimulating yen carry trades. The U.S. Commodity Futures Trading Commission (CFTC) separately tracks speculative positions in the yen. The power of the "Watanabe Wife" and yen carry trades was greatly diminished by the 2008 global financial crisis and the 2020 COVID-19 pandemic. This was because major central banks sharply lowered interest rates to prevent recessions.

With the return of high inflation not seen in 41 years in 2022, the interest rate gap between the U.S. and Japan widened. The yen’s value plummeted, and yen carry trades revived. Last April, HSBC assessed that the Bank of Japan is likely to raise its policy rate target three times by the end of 2025. Unlike Japan, where rates remain low, most major central banks have either started cutting rates or are preparing to do so. Rate cuts have become an unavoidable global trend.

The time of the Great East Japan Earthquake in 2011 still feels harrowing in retrospect. The Japanese sold overseas assets they had purchased cheaply with loans during the bubble economy and converted them into yen. The converted yen was used for reconstruction costs, causing yen appreciation. News of bankruptcies among hospitals and individuals who had used yen carry trades spread here and there. Hospitals borrowed yen instead of domestic bank loans to reduce interest burdens even slightly. If Japan’s rate hikes are a trend and global rate cuts are inevitable, it is important for the global financial order that such situations develop gradually. Bloomberg forecasts that global benchmark interest rates will fall by an average of 1.55 percentage points by the end of next year. All eyes are on interest rate cuts and changes in asset markets.

Jowon Kyung, Professor at UNIST & Director of the Global Industry-Academia Cooperation Center