Yen Carry Trade to Unwind - Market
There is a very important
development regarding the YEN carry trade. I deem this important
enough to post a market crash alert.
The Japanese economy is strengthening enough
to cause an unwinding of the massive YEN carry trade. The
last time this happened, there was the LTCM collapse.
Japan has had enough economic growth these last
quarters, in production growth and consumer spending, that
the BOJ may well end the policy of zero interest rates in
That zero rate interest policy has lasted about
ten years, and is the first source of the liquidity bubbles
world wide, and is very much a part of the liquidity bubbles
here in the US. Once the BOJ starts to raise interest rates
in Japan, the Yen carry trade will start to unwind.
The Yen carry mechanism is to borrow Yen at
virtually zero rates, and then to purchase US treasuries at
about a 3% interest rate gain net. There are literally trillions
USD of yen carry trade positions scattered amongst hedge funds,
insurance companies, and mutual funds. The phenomena is so
widespread and has gone on so long, that the BOJ and even
the BIS does not have data on the known net amount of YEN
carry trade floating out there in the world. The result is
that the effects of an unwinding of the Yen carry trade are
unknown, but are sure to be very negative.
Here are the kinds of things that will happen
when the Yen carry trade is unwound:
• US treasuries will become less desirable,
much of the purchases of UST’s last year were from foreign
private entities who bought the UST’s to benefit from
the interest differential of about 3% net over Japan.
• UST’s were not the only beneficiaries
of the Yen carry trade. Markets world wide are given massive
amounts of liquidity, as Yen borrowed for virtually nothing
are then invested eventually in foreign stock markets everywhere.
Real estate markets also benefit greatly, as the Yen carry
trade finds its way into real estate markets from Shanghai
to the US to everywhere. The BOJ literally acts like a central
bank of the world through the Yen carry trade, supplying liquidity
that finds its way into markets everywhere.
The phenomena is a decade old now for the latest
manifestation. The last time this level of penetration of
the Yen carry trade was reached was just prior to the LTCM
collapse. Back then, when the Yen unexpectedly strengthened
20% it caused a massive move out of Borrowed Yen on the Cheap,
and caused massive market sell offs world wide, and was a
direct cause of the LTCM collapse, where the US FED had to
act immediately to bail out banks and illiquid brokerages
and financial entities with blank checks to forestall that
We are again facing a very similar dilemma now,
with the present significant strengthening of the Japanese
economy, and the prospect of a rising Yen and a rising Japanese
interest rate environment. Both of these trends hit the Yen
carry trade on two sides.
This could cause a massive move out of the Yen
carry trade, as those positions are unwound quickly to get
out in advance of as many others as possible. This is because
that Yen carry trade has gone on for about ten years and the
accumulated positions are just astronomical.
It is for this reason that I am issuing my third
market crash alert for 2006.
I don’t like issuing these, but when I
see such an event pending, I just have to give the alert.
This is not something I like doing. An alert does not mean
there must be a crash, only that there is a serious new risk
Here is a link to a superb article at Bloomberg
about this issue. I have paraphrased some of it above.
“Bloomberg: Remember 1998
In October of that year, Russia's debt default
and the implosion of Long-Term Capital Management LP shoulder-checked
global markets. The disorienting period culminated in the
yen, which had been weakening for years, surging 20 percent
in less than two months.
Suddenly, just about anyone who'd borrowed cheaply
in yen rushed for the exits. It prompted frantic conference
calls among officials in Washington, Tokyo and Frankfurt.
Just how big was the yen-carry trade? How much leverage was
involved? What could policy makers do, if anything, to regain
Since then, the wild days of 1998 have been
largely forgotten. And as Japan slid back into recession and
deflation, the yen-carry trade was back in favor. Trouble
is, just as then, officials have little data to go on to understand
the enormity of the risks all this poses. “
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