- The Yen Carry Trade triggered a global market crash, causing Bitcoin to drop below $50,000.
- Traders borrowed Yen at low rates to invest in higher-yielding assets like tech stocks.
- Japan’s Ministry of Finance intervened, selling US Treasuries to temporarily boost the Yen’s value.
- The unwinding of Yen Carry Trades may cause further market sell-offs and financial instability.
The recent market crash caused by the Yen carry trade strategy has sent shockwaves across global markets. Trillions of dollars vanished, and Bitcoin dropped below $50,000 for the first time since February.
So, this raises an important question: how does a single trading strategy lead to such a devastating market crash? CoinBureau in its recent video explained what went wrong and why it could happen again.
What is a Carry Trade?
A carry trade involves borrowing money at a low interest rate and investing it in assets that yield higher returns. CoinBureau gave an example with two banks. One offers loans at 0% interest, while the other offers a 10% return on investments. So you could borrow $10,000 from the first bank and invest it in the second bank, earning $1,000 in profit without paying any interest. This is the essence of a carry trade. The difference in interest rates, known as the “delta,” is what traders exploit to make money.
However, CoinBureau warns that carry trades are more complicated. They involve factors like foreign exchange rates, funding rates, and leverage. Despite these complexities, carry trades remain a popular strategy among traders worldwide.
The Japanese Context: How the Yen Carry Trade Became Popular
The Bank of Japan (BoJ) for years, the BoJ maintained an interest rate of -0.1% to combat deflation, a persistent problem in Japan’s economy. Deflation, where prices drop and consumers delay purchases in anticipation of even lower prices, can lead to a vicious cycle of reduced spending, lower production, and higher unemployment. So, to prevent this, the BoJ made money essentially free, hoping to stimulate economic activity.
However, CoinBureau points out that this policy had unintended consequences. Traders around the world took advantage of Japan’s near-zero interest rates to borrow Yen and invest in higher-yielding assets. By borrowing Yen at low rates and investing in assets like tech stocks, government bonds, and even Bitcoin, traders shorted the Yen, creating pressure on Japan’s financial system.
The Risks of the Yen Carry Trade: Synthetic and Natural Short Positions
The Yen Carry Trade became popular, especially after the Federal Reserve began raising interest rates in 2022. As the Fed hiked rates, central banks in Europe and the UK followed suit, creating a widening delta between Japanese rates and those in other countries. CoinBureau explains that this made the Yen Carry Trade a no-brainer for hedge funds looking to profit from the difference in rates.
The scale of the Yen Carry Trade is difficult to measure, but estimates range from $1 trillion to as much as $20 trillion, according to Deutsche Bank which is 55% of Japan’s GDP. So, CoinBureau points out that this lack of consensus shows how complex and opaque the global derivatives market is.
Furthermore, the depreciation of the Yen between March and October 2022, losing a third of its value against the dollar, fueled the carry trading. Traders began to see the Yen as a tool for a short trade, betting that its value would continue to fall.
Yen Carry Trade Interventions: The Japanese Government Steps In
As the Yen’s value continued to plummet, the Japanese Ministry of Finance stepped in with measures to prop up the currency. In September and October 2022, they sold $60 billion of Japan’s US Treasury reserves to buy Yen on the open market. So, this move, termed “Yenterventions,” temporarily boosted the Yen’s value by 16% against the dollar. However, CoinBureau notes that this recovery was short-lived. By January 2023, the Yen downward slid again.
The second Yentervention occurred in April-May 2024, when Japan sold another $62 billion of US Treasuries. So, this time, the Yen’s rally lasted a week before losing all its gains by the end of June. CoinBureau explains that these interventions were ultimately ineffective because they did not address the main issues driving Yen’s depreciation.
Additionally, the BoJ’s policies were also part of the problem. While the Ministry of Finance was selling US Treasuries to prop up the Yen, the BoJ was printing more Yen through policies like quantitative easing and yield curve control. This contradictory approach, CoinBureau argues, was like “burning the candle at both ends.”
Mission Accomplished?
By 2022, Japan’s long battle with deflation seemed to be over. Inflation began to rise sharply, peaking at 4.3% in January 2023. This made the BoJ change its monetary policy, claiming an end to the deflation era. In March 2024, the BoJ raised its policy rate for the first time in 17 years, from -0.1% to a range of 0% to 0.1%. Although this increase was small, CoinBureau noted that it was huge in relative terms.
However, BoJ Governor Kazuo Ueda downplayed the rate hike, saying, “Today’s decision will only lead to a 0.1% increase in short-term interest rates.” So, this reassured carry traders, after all, borrowing Yen at near-zero rates was still attractive.
The Turning Point
Things began to change in July 2024. The Yen hit a 38-year low against the dollar. CoinBureau reports that tightening labor market data and rising inflation in Japan increased the likelihood of another rate hike. The Secretary-General of Japan’s ruling party even urged the BoJ to act, and a key government advisor warned that a rate hike was necessary to prevent the Yen’s weakness from hurting consumption.
So, a second rate hike would make many carry trades unprofitable and could signal the start of a new rate-hiking cycle. CoinBureau explains that some traders began to exit their Yen carry trades in anticipation of the hike, but many others continued to short the Yen, betting that the BoJ would hold off on further increases.
The Second Hike
The BoJ’s July meeting proved to be a turning point. CoinBureau notes that most traders and economists expected the BoJ to hold rates steady until October. However, the BoJ surprised the markets by raising rates again, catching many carry traders off guard.
The impact of this unwinding was felt across global markets. As traders scrambled to cover their positions, asset prices began to fall. So, the resulting sell-off wiped out trillions of dollars in market value, with Bitcoin dropping below $50,000 for the first time since February. CoinBureau warns that this could be just the beginning, as they expect carry trades to continue.
The Unwind: What Happens When the Yen Carry Trade Unravels?
- In the short term, CoinBureau predicts that the market sell-off will continue as traders unwind their carry trades. “The Yen is likely to appreciate further, putting more pressure on those who borrowed Yen to invest in higher-yielding assets.” So, this could lead to a wave of margin calls and forced liquidations, causing a market crash.
- In the medium term, CoinBureau suggests that the BoJ may continue to raise rates, especially if inflation remains above target. Investors may begin to seek safer assets, driving demand for US Treasuries and other low-risk investments.
- In the long term, CoinBureau warns that the unwinding of the Yen carry trade could have far-reaching implications for the global economy. So, the use of this strategy means that its collapse could trigger a financial crisis, particularly if other central banks follow the BoJ’s lead and raise rates.
Conclusion
The Yen Carry Trade has been a lucrative strategy for many traders, but its recent collapse has shown the risks involved. As CoinBureau explains, the combination of Japan’s low interest rates and the global search for yield created a perfect storm.
Also, the BoJ’s recent rate hikes have triggered a massive unwinding of carry trades. Leading to a market sell-off and Bitcoin’s fall below $50,000. Do you see another market crash on the horizon?
CoinBureau status; Image source
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