Bloomberg Audio Studios, Podcasts, radio News. I'm Stephen Carol and this is Here's Why, where we take one news story and explain it in just a few minutes with our experts here at Bloomberg. It's been a popular trading strategy for many years, borrowing in one currency to invest in another, at least until recently.
And the yen rally intensifies as carry trades onwind jgbs for the most since nineteen ninety nine, as the topics enters eight per market territory. This is the worst day since nineteen eighty seven for Japanese equities. What is happening and driving.
These extreme moves in the market that are winding of the carry tree.
I'll tell you.
We talk about China exporting deflation to the rest of the world, tom in this case, Japan is exporting inflation to the rest of the world.
Japan story. The carry trade is actually causing a little bit of chaos in the markets, and I think that you know, there really has been an immediate reaction to that.
The carry trade was a key part of the market turmoil we saw in early August, which included big moves on currency, equity and bond markets over a number of days. Since then, lots of questions are being asked about the future of the strategy. So here's why the carry trade will carry on. Our managing editor for Foreign Exchange in Rates, Rachel Evans, is with us for more. Rachel, first of all, can you explain what exactly the carry trade is?
Yeah, it's one of these terms that we tend to throw about willy nilly without really defining it particularly well. But basically it's pretty simple. It's just borrowing something at a low cost or low rate in one country to
invest in something with a higher yield somewhere else. So for example, in this case, we've been talking a lot about kind of borrowing in the yen, which obviously is at kind of very very low levels right now, and investing it in places like Mexico whereon so yielding a really chunky, nice yield, or in US tech stock where obviously we've seen stocks like in video going on a
real tear. So it's really just that kind of you know, looking for cheap money to invest in something that's going to pay you back in a bigger way.
So what exactly happened to this trade then? During the market termoil. We saw at the start of August.
We've seen a few wobbles in this trade for kind of prior weeks, US tech stocks having days where they'd sold off, for example, and we had been sort of talking a lot about kind of how stretch positioning had become in the end. We're just everybody seeming to expect the end to stay weak for a longer period of time, and then in a very short amount of time we
had a few events that really rocked that expectation. We saw the FED holding rates but signaling that it would start to cut In September, we saw the Bank of Japan raising interest rates and this was the second hike that they'd done. And then we also saw job s data coming and suggesting that the US economy was weaker
than previously anticipated. So all of that kind of put together the idea that Bank of Japan wasn't just going to keep rates really really low in definitely that they were going to start increasing those and kind of be on a path towards higher rates, and the fact that that the US economy perhaps was wabbling and the FED
may maybe behind the curve. Those sort of sentiments really kind of combined to prompt everybody to take a really sharp look at some of the trades that they've been considering as no brainers for the year and really start unwinding those at breakdeck speed.
Have we seen this sort of thing happen before where such a popular trading strategy in the carry trade has essentially become very unpopular very quickly.
I mean, the carry trade is particularly prone to these rapid unwinds because it does rely on stability, It relies on a lack of volatility for it to really kind of work and pay off. So back in nineteen ninety eight, we saw a pretty sharp reversal. We saw the end then rise sixteen percent in one week, which is, you know, put things in perspective, Yeah, exactly. I think we saw a three percent rise on Monday when things were were
at their worst here. But then we saw this in two thousand and seven when we were dealing with the ripple effects at the subprime crisis. So when we do see kind of some of these exogenous events like geopolitical turmoil come in and sort of boost currency like the yen, which has tended to be favored by carry traders to fund these positions, that can really disrupt this trade, and so this is not the first time it's kind of happened.
What about the carry trade using currencies other than the yen, have they seen the same sort of effect that we've seen with the n trade.
Yeah? Similar. I mean, the yen has very much been kind of the dominant currency for obvious reasons. It's very very liquid, it's easy to get in and out, and there has been this kind of very long narrative of low rates in Japan. But we have also seen people using the Chinese yuan to fund carry trades as well. So when we were seeing kind of the height of the gyrations last week, we did see the yuan also strengthening alongside the yen, and that's been a bit of
a pattern. You know, when we have seen kind of the yen having days of strength, it's tended to kind of come alongside some Yuan strength too, with a sense of kind of like this unwind of carriers really fueling both both positions.
Does this mean the carry trade has has last its shine? Is this a fundamental change?
I certainly lost its shine for now, but like everything, you know, nothing really goes out of style for very long. And in fact, I was just looking at some of the gauges of carry on the Bloomberg terminal and noticed that there's a there's a gauge of dollar funded carry trades in emerging markets that's up two percent since last week. So clearly, you know, if you got in at the bottom when everybody was really sort of heading for the sidelines,
you could have actually made a pretty nice profit. So these things sort of tender to kind of come around. But it does feel like we're getting a bit of a rethink of exactly how invested in this trade you really want to be. How far do you want to kind of sort of blow out your profit Marge and betting on this one strategy, And do you want to diversify perhaps a little bit beyond just using the end to kind of fund these these carry trades?
So what sort of event could reinvigorate this trade? And can I take a gas and it's at the central banks?
Central banks are always crucial to this.
Yes, I actually the answer to everything pretty much pretty.
Much in macroland. I think there are two things that kind of have the potential to reinvigorate the trade. The first would be a boring answer, stability. Everybody in this trade needs stability, They need a sense that they know what's going to happen and a sense of certainty. Now the Bank of Japan is keeping rates very low for quite a long time, it would seem like we're not talking about huge interest rate increases. We're at zero point
two five percent now. This is this is not particularly dramatic given where we are in the US or in the UK in terms of where interustrates are. So once people get a sense of kind of certainty that they're not going to suddenly, you know, high rates to one percent, two percent or higher, then I think you could see some sort of re establishment of these bets. Given that the thesis of borrowing low and investing in higher yielding
currency still really holds. You just need to be prepared that you're not going to get quite as much for that. The other possible reinvigoration would be if we see something idiosyncratic happen, where we see interest rates in one country cut a much much lower than elsewhere. It's very hard to predict what would cause that. It would be some sort of local political drama, local economic drama that would see interest rates somewhere become much much lower than the
rest of the world. But yeah, we'll have to see exactly where and when that might happen.
Thank you, Rachel Evans, our managing editor for Foreign Exchange and Rates. For more explanations like this one from our team of twenty seven hundred journalists and analysts around the world, search for quick take on the Bloomberg website or Bloomberg Business app. I'm Stephen Carol. This is here's why. I'll be back next week with more. Thanks for listening.