Yen Carry Trade Risks Increasing
The financial markets are on the edge of a deep abyss. A fall into that abyss may well be triggered by the massive unwinding of the Yen carry trade on world financial markets.
In it’s most basic terms the Yen carry trade is a transaction where borrowers borrow Yen at very low interest rates, convert Yen into other higher yielding currencies, and use the proceeds to purchase higher yielding assets.
The carry trade has worked well over the past several years as a weak Yen and extremely low rates of interest in Japan have been a given.
However, now that the Yen is increasing in value massive losses are beginning to appear on the books of those who put on the carry trade in huge amounts. This would include hedge funds, Wall Street and other investment banks around the world, and large private investors. As the losses multiply these “investors” are forced to sell other securities that they may not really want to sell to be able to honor redemption requests and to meet margin calls.
The result of forced liquidations in the Yen carry trade is to send the Yen even higher against other currencies and force another round of selling on world markets.
While over the past few years the carry trade has provided a great deal of liquidity to world financial markets, including the real estate market, the unwinding of the Yen Carry trade works to reduce liquidity. Therefore there is the risk of a severe credit crunch should the heavy liquidation of carry trade positions continue.
It is not a time to be a bold investor or borrower. It is likely to be a very good idea to increase your cash holdings while you still have a little time. October is historically a bad month for stock markets and this year could be one for the record books.
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