Please see the below update from EPIC Investment Partners on a current focus point for global markets, the rise in Japan’s interest rates and the implications for the Yen carry trade. Received yesterday – 08/08/2024
Please see the below update from EPIC Investment Partners on a current focus point for global markets, the rise in Japan’s interest rates and the implications for the Yen carry trade. Received yesterday – 08/08/2024
The recent volatility in the Japanese yen, culminating in a sharp appreciation against the dollar, has sent shockwaves through global markets. While some have interpreted the Bank of Japan’s (BOJ) recent comments as dovish, a closer look reveals a different picture. BOJ board members, including Naoki Tamura, have indicated that the neutral interest rate in Japan is likely above 1%, suggesting that the central bank has ample room to tighten monetary policy further. This revelation should have triggered a reassessment of the yen’s trajectory and the viability of the long-standing yen carry trade. Unfortunately, some have misinterpreted the recent BoJ comments as dovish, adding to their short yen positions.
The yen’s recent strength signals an end to the era of the yen carry trade, a strategy built on the flawed premise that Japan’s low interest rates would persist indefinitely. This trade, where investors borrow yen to invest in higher-yielding assets elsewhere, has always been a house of cards, propped up by investor naivety and a misunderstanding of economic fundamentals.
Japan’s persistent trade surpluses and vast net foreign assets (NFA) paint a different picture. These assets, representing Japan’s claims on the rest of the world, have long suggested that the yen was undervalued. Yet, the allure of easy profits blinded many investors to this reality. As BOJ board member Toyoaki Nakamura put it, “The real effective exchange rate of the yen is still weak compared with its long-term average.”
The carry trade’s unwinding isn’t merely a technical adjustment; it’s a long-overdue reckoning. As investors repatriate capital to Japan, seeking the safety of a creditor nation with a strong economic foundation, the yen’s appreciation is set to continue. The BoJ’s path towards policy normalisation, even if gradual, further reinforces this trend.
The fallout of this unwinding is already evident in the Tokyo stock market’s recent tumble. However, the implications extend far beyond Japan. The dollar, as the world’s reserve currency, has been artificially propped up by the carry trade’s distorted incentives. As the yen strengthens and the carry trade unwinds, the dollar faces a looming reckoning, especially as the Federal Reserve signals a potential easing of its monetary policy.
The yen’s ascent is a harbinger of a broader shift, a signal that the era of easy money in Japan and distorted valuations is coming to an end. The fact that the Fed is set to ease will further undermine the US dollar, accelerating this shift. Investors who fail to heed this warning do so at their own peril.
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Alex Kitteringham
9th August 2024