Overview
Skip and Samantha start by explaining the basic idea behind a carry trade. Investors borrow money in a currency with a very low interest rate — the funding currency — and then invest that money in currencies or assets offering a higher yield. For decades, Japan’s rock-bottom interest rates have made the yen an attractive currency to borrow.
They then look at where this borrowed money goes. Carry trade investors can put their capital into higher-yielding currencies, government and corporate bonds, global equities, real estate, and other assets. Large institutional investors can also use leverage and foreign exchange derivatives to amplify relatively small differences in interest rates.
Next, Skip and Samantha discuss why the Bank of Japan is changing the situation. After years of extremely low and sometimes negative interest rates, the BOJ has begun raising rates as Japan moves away from its long period of deflation. Higher Japanese interest rates make borrowing yen more expensive and reduce the potential profit from the carry trade.
They also look at Japan’s enormous retail foreign exchange market and the financial nickname ‘Mrs. Watanabe’.
Finally, they examine what can happen when the carry trade begins to unwind. The market trouble of August 2024 showed how leveraged investors can be forced to sell liquid assets, including US technology stocks, when markets suddenly move against them. With the yen historically weak, interest-rate differences changing, and governments intervening in currency markets, the future of the yen carry trade has become an important issue for global investors.
