By Michael Scott
Carry trade investors rush to cover the yen bets plunge risk asset prices in the global market rout.
The vulnerability of the interconnected global economy became evident on Monday’s sell-off. The focus points to the Bank of Japan (BOJ) move to hike interest rates with traders financing via Yen-denominated debt, the culprit of the recent rout.
The higher rate has bolstered the yen value by 10% relative to the US dollar, as shown in TradingView data. Notably, the largest crypto by market value, Bitcoin, is down 20% over the past seven days. BTC breached the $50,000 resistance level on Monday, the first incident since February.
Carry Trade to Blame for Market Downturn
Jake Ostrovskis, a leading OTC trader within Wintermute, considers the downturn to be a consequence of the carry trade unwinding rapidly. He added that trade involves obtaining Yen-denominated debt at virtually low interest rates and investing the proceeds within the higher-yielding assets.
The depreciation of yen’s value allows traders to leverage the low cost to realize profit by holding assets denominated in different currencies. Additionally, the traders often juice the returns by investing the converted funds into high-yield assets.
The BOJ announced an interest hike to raise the yen’s borrowing costs in a rare move witnessed 17 years ago. Ostrovskis observed that the BOJ signaled likely to issue subsequent hikes, thus eroding the attractiveness of the yen-based carry trade.
As traders sell the risk assets and convert others to Yen, the Japan currency is stronger. The development has risk assets such as crypto and equities battling higher volatility. Additionally, they experience higher downward pressure as traders close their positions.
The rush to acquire Yen to close the earlier positions yields more pain for subsequent borrowers seeking Yen-denominated loans. Asylum Ventures shareholder John Wu revealed in a recent X (formerly Twitter) post that the development is a “double-whammy” behind cascading liquidations.
Amberdata derivatives head Greg Magadini notes the traders portray haste to exit. The aggressive sell-off emerges from virtually all investors having a common stance. He added that the crowding witnessed in the yen-carry trade arises from an obvious trade.
Besides the hurdles imposed by BOJ to break down carry trade, the meltdown is caused by a convergence of factors. Magadini notes that the fears of recession have been a concern, particularly after the weaker-than-expected job growth.
Gold and Crypto Engulfed by Market Rout
Magadini considers the market turmoil to also arise from the geopolitical tensions witnessed within the Middle East. The conflict is compelling investors to embrace the risk-off approach, leaning towards the short-term.
Magadini decries that the markets turned haywire suddenly. Not a single segment escaped the wrath, with tech-affiliated stocks leading gold and crypto in the widespread downtrend. He illustrated that the Japanese yen appears as a canary within the coal mine.
Cube.Exchange chief Bartosz Lipinski echoes Magadini’s view that the yen-carry trade is an early warning of danger. In particular, the liquidations emerging from the yen-carry-trade breakdown aggravated the pain witnessed within the markets.
Lipinski considers the compounding pain inevitable as traders would previously borrow yen at nearly free levels. The liquidity would allow them to express opinions across other assets.
Beyond Japan, uncertainty witnessed within the Middle East adds to the fears of a recession in the US. Such constitutes grounds for many traders to consider a risk-off move.