S&P Global BMI fell 3.3%, worst day in 2 years
TOPIX dropped 20% in three days
Yen appreciated 10% against USD
BOJ Deputy Governor pledged to avoid further rate hikes
JPMorgan estimates carry trade unwind only halfway complete
Similar yen movements occurred in 1998 LTCM crisis and 2007
Opinion
The current market turmoil shows deeply troubling parallels to previous financial crises. The rapid unwinding of yen carry trades, with only half the process complete according to JPMorgan, suggests potential for significantly more market disruption ahead. Most concerning is how this is affecting multiple asset classes simultaneously, from equities to crypto, indicating potential systemic risks that could trigger broader market instability.
Core Sell Point
The incomplete unwinding of massive yen carry trade positions, combined with historical patterns suggesting further yen appreciation ahead, indicates potential for more severe market disruptions that could trigger a broader financial crisis across multiple asset classes.
Last Monday, global equities and digital assets underwent a dramatic selloff as the unwinding of the Japanese yen carry trade rattled markets. The S&P Global Broad Market Index (BMI), which measures the performance of more than 14,000 stocks around the world, retreated 3.3%, its worst trading day in over two years. The Tokyo Stock Price Index, or TOPIX, fell 20% in its biggest three-day wipeout ever. Meanwhile, the Bloomberg Galaxy Crypto Index tumbled as much as 17.5%.
As an investor who’s weathered numerous market storms over the decades, I believe it’s important to understand the underlying causes of these movements and the lessons they hold for us.
Carry trades, for those less familiar, involve borrowing in a low-interest-rate currency—like the Japanese yen or Swiss franc—and investing the proceeds in higher-yielding assets elsewhere. This strategy has been immensely profitable, given the Bank of Japan’s (BOJ) longstanding zero-rate policy.
However, the recent rate hike by the BOJ has thrown a wrench into these trades, leading to a rapid appreciation of the yen against the U.S. dollar. As many of you are aware, a strong local currency can put pressure on that country’s stock market because exported goods become less competitive. The yen’s appreciation mirrored past episodes, such as the 1998 Long-Term Capital Management (LTCM) hedge fund collapse and the 2007 subprime mortgage crisis, where the yen appreciated 20% from its low. As of early August, the yen had already appreciated over 10% against the U.S. dollar.
Following the selloff, the BOJ walked back its hawkish stance, with Deputy Governor Shinichi Uchida pledging to refrain from further rate hikes amid market instability. This should provide some relief in the near term, but the broader implications of the yen’s rebound and the carry trade unwind will likely continue to influence markets.
Given these developments, I urge caution. History suggests that the unwinding is not yet complete. In a report dated August 9, JPMorgan says it believes the unwind is about halfway done. What’s more, financial markets are pricing in multiple rate cuts by the Federal Reserve this year, which could further exacerbate the carry trade unwind. In such a scenario, it’s prudent to remain cautious about “buying the dip.”
