The Impact of the Yen on Global Markets

Markets have faced a turbulent week. Poor Labour reports combined with the Federal Reserve’s decision not to cut interest rates has fuelled fears of a US recession. Meanwhile the value of the Japanese Yen rose to a 7 month high as the Bank of Japan chose to raise interest rates for only the second time in 17 years and reduce bond purchases. The last few days has seen investors selling off US Tech Stocks to protect themselves from losses. But what does the strength of the Yen imply for global markets?

The volatility of the last few days has cast a light on the Yen carry trade. A carry trade is where investors borrow from a country with a weaker currency and low interest rates, then reinvesting in another country with a higher rate of return. For over 20 years, Japan’s zero-interest rate policy has made it a viable choice for carry trades for both overseas and Japan’s retail investors. The strong dollar made the US a safe bet for higher returns and the AI Boom has fuelled the popularity of tech options. For carry trades to remain profitable, the yen needs to remain week. So when the yen rose over 3% against the dollar, cautious investors rushed to unwind their bets on the yen to avoid losses.

According to the Bank for International Settlements (BIS) global borrowing against the yen increased by $742 billion since 2021. The US markets do not exist in isolation and the sell off in tech stocks impacted markets across the globe. Whether the carry trade can be stabilised depends on whether the yen continues to strengthen against the dollar. Current expectations are that the Yen will continue to strengthen in the coming month, ahead of a hoped for cut in interest rates by the Fed in September.

(Source: economictimes.com)