New Recession Fears and The Great Yen Carry Trade Unwind
Weekly Market Recap | Aug 5 - 11, 2024
The yen carry trade unwinding that tanked the market
The main story of the week was easily the massive unwinding of the yen carry trade that tanked markets across the globe. Here’s how it happened.
The yen carry trade 101
Ever since 1995, Japan’s leading interest rate has been no higher than 0.5%. From January 2016 through 2023, interest rates in Japan were even negative. Only in March of this year, the Bank of Japan raised rates from -0.1% to 0.1% before giving them another hike to 0.25% in July.
Meanwhile, the US, EU, and many other countries raised rates aggressively throughout 2022.
Furthermore, the Japanese yen lost 40% of its value against the US dollar since early 2022.
All of this created an extremely fertile environment for the yen carry trade:
Borrow yen at an extremely low cost
Convert your borrowed yen to another, stronger (and strengthening) currency (e.g., the US dollar)
Invest your money in dollar-denominated assets to earn a yield (e.g., short-term treasury bills with a “risk-free” yield or riskier assets like stocks or crypto)
Earn a yield from the assets you bought (for borrowed money) as well as the yield achieved by the US dollar strengthening against the yen
This trade worked wonders for as long as the BoJ kept rates near zero, other central banks kept rates high, the yen kept weakening, and financial markets kept going up.
The great unwinding
First up, the yen gained 10% in just three weeks during July. This alone caused massive losses for anyone in the carry trade.
Next, the Bank of Japan raised interest rates at the end of July and signaled more hikes to come. They also confirmed a $36.8 billion currency intervention throughout July, explaining the strength of the yen.
The Fed then all but confirmed a rate cut at the upcoming meeting in September. This caused bond yields to drop to their lowest levels since March.
On top of all that, a US jobs report and some disappointing earnings caused risk assets to sell off.
This set off a cascading effect as more and more traders were forced to liquidate their positions due to mounting losses. Stock markets around the world got hit, some with outright crashes. The crypto market plummeted as well. And just like that, the great yen carry trade unwind had unfolded—at least partially.
For now, markets have stabilized and rebounded. It will be an interesting situation to follow in the coming days and weeks. Will investors flock back into the trade if/when conditions are once again ripe? Or will they stay away after this scare? Time will tell.
In other news
As briefly mentioned above, the US nonfarm payrolls painted a less-than-rosy picture of the economy. The pace of new jobs was significantly slower than projected and the unemployment rate jumped from 4.1% to 4.3%.
Weekly jobless claims in the US fell to 233,000, less than the 240,000 expected. Although it’s typically not a number that moves the markets, this was a positive sign for the markets after a week of recession fears and turmoil.
Kamala Harris picked Minnesota governor Tim Walz as her running mate. It didn’t take long for him to begin attacking J. D. Vance and catch some flag himself. The latter revolved around his ditching his troops when being ordered to serve, and the fact that he continued to use a title he didn’t really have.
In more politics, Trump and Harris seem to be ready for a live debate in September.
Disney reported on Wednesday and topped estimates for both revenue and earnings. Their theme parks are under pressure though. The stock dropped 4.5%.
Robinhood reported a record revenue of $618 million and significantly beat expectations. Shares jumped 3.6% the day after.
Novo Nordisk disappointed and dropped 7%. They lowered their expected growth for 2024 from 24 - 30% to 22 - 28% and cited margin pressure.
Eli Lilly did the opposite of Novo the day after, beating expectations and getting a +9% boost in the market.
Berkshire Hathaway sold half their Apple position in another move to build their stash of cash. This comes with a surprise twist. Apple’s weighting in a slew of benchmarks has been depressed for years because Buffett’s Berkshire Hathaway tends to hold its investments for the long run, making them unavailable for trading. As a result, index providers calculated the tech company’s weight based on a methodology known as float-adjusted market capitalization. Put simply, Apple’s true value is not reflected in many indexes. But that’s about to change. Source: Bloomberg
Brazil’s inflation rate rose to 4.5% in July, the upper end of the target range. It was just a bit above expectations.