The Yen Carry Trade

For 30 years if not more, global investors have benefited from the Yen Carry Trade (YCT). The operation is simple: you borrow at very low rates in Yen, to invest in high yield or high return assets elsewhere, mainly in the US. If the Yen stays stable or weakens, you make a killing. But rates in Japan have started to go up, because for the first time in 30 years, and after spending a fortune in monetary stimuli, Japan has a little bit of inflation. As a consequence short rates have gone up, and also Japanese long bonds yields have gone vertical, as you can see in the chart below. It no longer makes economic sense to borrow in Yen to invest in U.S. assets, as the rate differential is no longer as favorable, with enough cushion to support the risk. On top of that, the central Bank of Japan is the biggest international investor in U.S. treasuries, and there is an argument to be made where it no longer makes sense to maintain those bonds. It’s stating to make more sense to by JGBs, than Treasuries. Estimates for the amount of money involved in the YCT are on the trillions, and partial unwinds have ripple effects like the episodes we are seeing in the U.S. equity market lately, where everything falls in unison. As the Fed lowers official rates and Japan hikes, the odds of YCT extintion rise. And that means less support for US assets.

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