For those wondering why the sudden increase in volatility, common thought dictates it is based on the Japanese Yen strengthening against the US dollar.

 

Many institutions are doing what is called a “carry trade” – they borrow Japanese Yen and use that money to buy other investments. For the last 30 years, the interest you had to pay to borrow the Yen was 0%. Institutions borrowed Yen and converted it to USD to buy US treasury bills, US Stocks, and, to a lesser degree, European stocks and bonds. This all works fine when your cost to borrow is zero and the value of the Yen is dropping against the US dollar.

 

However, inflation in Japan has been rising lately and the Bank of Japan increased the interest rate to 0.25%. This was not expected (and almost unprecedented). The result is a signal to the market that the Bank of Japan is concerned about inflation and may begin to raise rates even further for the first time in 30 years.

 

This has caused concern amongst the “carry trade” investors, making them unwind their trades. This means they have to sell their US dollar investments and repurchase the Japanese Yen to pay back their loans. This is causing the Yen to strengthen even more against the US dollar, which in turn is making it even worse for the “carry trade” investors, and the spiral continues!!

 

The real issue is that we don’t know how big this trade is and how long it will take to unwind. We should find out soon...

 

As always, if you have any questions, please feel free to give us a call at any time.

 

Have a great week.

 

Milan