Yen Strengthens Amidst Ongoing Carry Trade Unwind
The unwinding of the yen carry trade, which saw a significant sell-off in August, may continue in September, potentially leading to another wave of market disruption, according to Kathy Lien, Managing Director of Forex Strategy at BK Asset Management. In an interview with CNBC’s “Squawk Box Asia,” Lien highlighted the potential for a repeat of August’s market turmoil if the current downward trends in U.S. yields and the dollar persist.
Current Market Dynamics
Lien explained that the risk-off sentiment currently prevailing in financial markets is likely to drive the ongoing unwind of carry trades. “We have a risk-off mood, which we’re already seeing across financial markets, and that is going to lead to the ongoing unwind of carry trades that we have seen already,” she noted. Traders are keeping a close eye on equity markets, which are typically volatile in September.
The Japanese yen has gained strength as U.S. yields and the dollar weaken. This shift follows the Bank of Japan’s decision to raise interest rates in August, which had previously kept the yen at historically low levels compared to other currencies. This rate hike triggered a substantial strengthening of the yen and a sharp sell-off in global markets.
Impact of Carry Trade Unwind
Carry trades involve borrowing in a currency with low interest rates and investing in assets that offer higher yields. The yen, with its historically low rates due to the BOJ’s negative interest policy, became a major focus of these trades. The recent unwind began in August, causing significant market volatility.
Richard Kelly, Head of Global Strategy at TD Securities, noted, “I think there is still a lot that can unwind, especially if you look at how undervalued yen is. That is going to change the valuations for the next one to two years to come. That’s going to have spillover effects.”
In August, the yen carry trade, estimated to be as large as $4 trillion, faced a major recalibration as global markets reacted to the BOJ’s rate hikes. The yen had strengthened for four consecutive days but recently weakened by 0.38% against the dollar, trading at 141.9.
Potential for Further Disruption
Analysts, including Lien, are concerned that ongoing shifts in market sentiment and potential further declines in U.S. equities could lead to aggressive sell-offs reminiscent of August’s turmoil. Wall Street indexes fell sharply last Friday, with the S&P 500 experiencing its worst week since March 2023, driven by weaker-than-expected jobs data.
Lien cautioned that continued negative trends in U.S. economic indicators could exacerbate market instability. “I do believe that there could be some periods of quite aggressive sell-offs in stocks this month, especially as the U.S. economy is moving in the direction that many of these central bankers fear.”
Japan’s Economic Outlook
Adding to the uncertainty, Japan’s Nikkei 225 led losses in Asia following disappointing second-quarter GDP data, which missed analyst expectations. Softer GDP growth may limit the BOJ’s ability to further raise interest rates, adding another layer of complexity to the current financial landscape.
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