How a popular trade collapsed — and why it matters
Digest
The podcast delves into the Yen Carry trade, a strategy where investors borrow in the low-interest Yen and invest in higher-interest currencies. The trade's popularity surged during the Lehman crisis and again in 2016 due to negative interest rates in Japan. However, the trade unwound in 2023 due to factors like the Bank of Japan's rate hikes, concerns about US economic activity, and crowded positions. The unwinding impacted various investors, with hedge funds experiencing a rapid unwinding and institutional investors in Japan facing a slower process. The podcast highlights the increased endogeneity in the market, where the initial Yen appreciation triggered a feedback loop that amplified the unwinding. This endogeneity, driven by concentrated risk and shared positions, contributes to market brittleness. The episode concludes by reflecting on the lessons learned from the Yen Carry trade unwind, emphasizing the importance of crowded positions, complacency in macro assumptions, and market microstructure dynamics. While carry trades will likely continue, the specific conditions and currencies involved may change.
Outlines
The Yen Carry Trade: A Comprehensive Analysis
This episode provides a comprehensive overview of the Yen Carry trade, a strategy involving borrowing in the low-interest Yen and investing in higher-interest currencies. The podcast explores the trade's history, its recent unwinding, and the implications for market structure and future carry trades.
The Yen Carry Trade's Rise and Fall
The podcast discusses the history of the Yen Carry trade, highlighting its popularity during the Lehman crisis and its resurgence in 2016 due to negative interest rates in Japan. The episode then explores the factors that led to the trade's unwinding in 2023, including the Bank of Japan's rate hikes, concerns about US economic activity, and crowded positions.
Market Impact and Future Outlook
The podcast examines the impact of the Yen Carry trade unwind on different types of investors, including hedge funds and institutional investors. The discussion highlights the potential for further unwinding, particularly from institutional investors in Japan, and the factors that could influence the future of the trade.
Lessons Learned and the Future of Carry Trades
The podcast concludes by reflecting on the lessons learned from the recent Yen Carry trade unwind, emphasizing the importance of crowded positions, complacency in macro assumptions, and market microstructure dynamics. The podcast acknowledges that carry trades will continue to exist, but the specific conditions and currencies involved may change.
Keywords
Yen Carry Trade
An investment strategy where investors borrow in a low-interest currency (like the Yen) and invest in a high-interest currency (like the US dollar or emerging markets). The goal is to profit from the interest rate differential and potential currency appreciation.
Sharpe Ratio
A measure of risk-adjusted return, calculated by dividing the average return of an investment by its standard deviation. A higher Sharpe ratio indicates a better risk-adjusted return.
Immaculate Disinflation
A scenario where inflation cools off without significantly impacting economic growth. This was the prevailing macro narrative at the start of 2023, contributing to the popularity of the Yen Carry trade.
Bank of Japan (BOJ)
The central bank of Japan, responsible for monetary policy and financial stability. The BOJ's decision to raise interest rates in July contributed to the unwinding of the Yen Carry trade.
Endogeneity
A situation where the outcome of a system is influenced by the system itself. In the context of the Yen Carry trade unwind, the initial appreciation of the Yen triggered a feedback loop that amplified the unwinding process.
Market Brittleness
A state where markets are susceptible to large and sudden price movements due to factors like concentrated risk and shared positions. The Yen Carry trade unwind highlighted the increased market brittleness.
Q&A
What is the Yen Carry trade and how does it work?
The Yen Carry trade involves borrowing in the Japanese Yen, which has historically had low interest rates, and investing in a currency with higher interest rates, like the US dollar or emerging market currencies. The strategy aims to profit from the interest rate differential and potential currency appreciation.
What factors led to the unwinding of the Yen Carry trade?
The unwinding was driven by a narrowing of the interest rate differential, as the Bank of Japan raised rates and concerns about US economic activity emerged. The crowded positions and the resulting volatility amplified the unwinding process.
How did the Yen Carry trade unwind impact different types of investors?
Hedge funds, which were more speculative, saw a rapid unwinding of their positions. Institutional investors in Japan, with their longer-term holdings, are likely to see a slower unwinding process.
What are the implications of the Yen Carry trade unwind for market structure?
The episode highlights the increased endogeneity in the market, where the initial appreciation of the Yen triggered a feedback loop that amplified the unwinding process. This endogeneity, driven by concentrated risk and shared positions, contributes to market brittleness.
What are the future prospects for carry trades?
Carry trades will likely continue to exist, but the specific conditions and currencies involved may change. The future of the Yen Carry trade will depend on the macro conditions, particularly the interest rate differentials between Japan and other countries.
Show Notes
The rapid unwinding of the Japanese yen carry trade is rippling through global markets. Goldman Sachs Research’s Kamakshya Trivedi, head of Global Foreign Exchange, Interest Rates, and Emerging Markets Strategy, and Praneet Shah, co-head of Global G10 FX Options Trading in Global Banking & Markets, explain the carry trade, why it matters, and the implications for investment portfolios.
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