Japan and the big carry trade

 

The yen carry trade has existed for decades. Borrow in cheap Japanese funding markets, sell yen, and then buy the currency of a high-yielding market in some other currency. Of course, hedging and risk management add layers, but the overall strategy is straightforward. Everything works until it does not, because of two things: 1) rates in Japan increase relative to the rest of the world, the yield spread falls; and 2) the yen appreciates, which can wipe out the gains from the spread differential. Now the Bank of Japan is raising rates, and the Finance Ministry is intervening in the yen markets to stop the currency slide. The net effect. is that less money will flow into foreign-yielding markets versus Japan. This will mean global rates will adjust higher.

Global bond markets are changing, and old sources of funding will no longer be available to borrowers. We can expect higher equilibrium real rates. We cannot say what the new rates will be, but the old environment is not working.