We have just seen the biggest one-day move on the Nikkei 225 since 1987. It’s clearly a bad day for stocks. A single summertime decision by Japan’s central bank ended up triggering a panic.
The stampede was so big that the meltdown just exploded in a massive pile of losses for everyone. And at the heart of all this? The Japanese yen and a massive global unwinding of the so-called carry trade.
Now that the dust has settled, everyone – from New York hedge fund managers and investors to Japanese business owners is left with an urgent question: do we need to rethink the role of the yen in the global economy? The yen is one of the most important currencies in the world. In the $7.
5 trillion-a-day currency market, it’s the third-most traded – behind only the US dollar and the euro. Every single day, more than $1,000,000,000,000 worth of yen exchanges hands. One of the main reasons why it's so heavily traded is because you can borrow yen cheaply and put it to work elsewhere.
That's because interest rates in Japan are so low, thanks to what's been a pretty sluggish economy over the past few decades. After booming in the 1980s, a combination of deflation, rising debt and an aging population has suppressed growth in Japan. So the central bank kept interest rates at rock bottom, to encourage borrowing and spending.
In fact, lower than rock bottom - for years, interest rates were actually negative. That kept the yen on a steady, weakening trend - which markets had come to rely on. That changed in March when the rate was raised to zero percent.
Which may seem minor, but here’s the thing When a central bank raises its interest rate at all, their currency tends to rally. For instance, the Federal Reserve embarked on their biggest rate hiking cycle since the 1980s, and the dollar absolutely soared. By one measure, it soared to an absolute record.
As central banks around the world began cutting rates in the summer as inflation in some places began easing, the Bank of Japan chose to keep going in the other direction and hike its rate – again. A lot of people actually were surprised. The explanation from the BOJ was that we’re seeing here prices go up, wages go up and there’s a risk here that inflation could get out of hand in the future.
The timing was spectacularly bad. Soon after, unexpectedly lackluster jobs data from the US sparked fears the Fed had waited too long to start cutting rates. Panic spread among investors and you can see that here, in Wall Street’s favorite fear gauge - the VIX.
It spiked to a level not seen since the pandemic. The market blew up. And worse was to come.
People are like, this carry trade, which seemed like the easy trade, is no longer. So you start exiting fast, and it starts to be self-fulfilling. Unwinds and unwinds and unwinds.
So what are carry trades, and why are they contributing to volatility in financial markets? In short, they’re a popular strategy of borrowing currency at a very low rate of interest - the yen, in this case - and investing it in something that pays you a higher rate. For example, you go to a bank and they offer you a credit card at 1% fees, but you can borrow at 0% interest.
You then borrow using that credit card and then use the proceeds to buy, say, a Google or an Australian bank stock or put that money to work in some corporate bonds, for example. Now, you might make a return from that trade because it's kind of like investing free money. But… …if things go incredibly wrong, you'll lose money both on the stock side and then you have to pay back your credit company as well.
Which is exactly what happened in August. Popular carry trade bets include US tech stocks, but right as this was all unfolding, a string of disappointing earnings from those companies sent their shares tumbling. And it all culminated in the Great Unwind, as we call it today.
The yen, which everyone had been selling to fund this carry trade, surged in value. All of a sudden, at the same time, people started selling everything that they had in order to cover those margin calls, they had to pay for their losses somehow. The yen triggered waves of volatility in global markets.
It’s also acutely impacting everyday Japanese back home. Here’s something not a lot of people know: Japan is home to the biggest army of retail currency traders in the world. And that really turbo charged the carry trade as we know it today.
You could be a hairdresser in Shinjuku, cutting hair during the day and going home at night, firing up the computer and trading yen against the Turkish lira or the U. S. dollar.
Or you could be a pensioner trading stocks as a hobby. Eighty-eight-year-old Shigeru Fujimoto, based in Kobe, began his amateur trading journey at age 19, while running a pet shop. He started day-trading using the internet at age 66.
He’s made about 2 billion yen since then, he says – that’s more than $13 million - and experienced several market crashes. Most recently, following the BOJ’s rate hike. .
. Fujimoto-san thinks Bank of Japan Governor Kazuo Ueda is in a difficult position. Elsewhere, one of the few bright spots in Japan’s economic outlook has been tourism.
The weak yen meant foreigners visiting and spending in the country got a lot more bang for their buck. Yoshiko Ota has been the general manager at Kyoto’s Towa Ryokan - a traditional Japanese inn - for the past 30 years. Most businesses in Japan are small- or medium-sized and those in the tourist sector benefited from the appeal of Japan’s culture - and its weak currency - to international visitors.
But a stronger yen is less appealing to tourists, and a higher interest rate makes it more expensive for companies reliant on them to service their debt. One of the biggest challenges in making sense of what’s happening to the yen, is understanding why it’s happening now. For the past couple of decades, Japan’s economy has been sluggish and stubborn wages, prices, growth… they’ve all stagnated.
And you could argue that that's been stability in a sense. But if you want gangbuster growth, Japan has not been the place to look for it. Until now.
Wages rose by 5% in 2024, unseen in 30 years. Inflation has stayed above the Bank of Japan’s 2% target, and so with growth finally emerging for the first time in decades, the last thing anyone expected was the BOJ to make any risky moves. Which is exactly what it did… They were looking at prices, they were looking at economic data, and they said this is data-dependent.
So that was the BOJ’s explanation as to why they decided to hike rates. After the chaos, the Bank of Japan actually came out to say that they wouldn't raise interest rates again if markets were unstable. What we've seen during this market crash basically is that what Japan does, what the Bank of Japan does, can have major implications for the rest of the world.
In global markets, many experts are rethinking just how strong or weak the yen should be given the uncertain path for interest rates in Japan. And that’s to say nothing of the prospects for popular carry trade targets like the Mexican peso or Brazilian real, which face headwinds of their own. For those back home, in Tokyo, or Kobe, or leafy Kyoto, uncertainty prevails, too.
