Why Markets Are Crashing -- The Yen Carry Trade Explained

This is an unusual Monday email, but it’s an unusual day.

At about 8:00 p.m. ET on Sunday night the crypto market — which trades 24/7 — started to collapse. That’s not all that unusual given the volatility of crypto, but this time is different.

Driving the move is the “yen carry trade”.

What is the yen carry trade?

In short, it’s borrowing Yen at very low interest rates and converting to another currency where higher yields can be found. It’s interest rate arbitrage!

In the past month, this trade has started to unwind as yields in the U.S. dropped and the yen got slightly stronger. On Sunday, the yen carry trade blew up. And it could take a lot of assets with it. I’m going to explain as best I can.

The Yen Carry Trade

The yen carry trade involves three pieces to work.

1. Borrow Yen at a low (~0%) interest rate.

2. Convert to another currency, likely USD.

3. Buy USD assets that yield over 0%.

As long as nothing changes, the trade makes money on the spread between U.S. interest rates and Japan’s interest rates.

It’s arbitrage and hedge funds LOVE arbitrage!

How the Trade Blows Up

The trade is amazing…until it isn’t.

If yen yields go up, the yen gets stronger vs the dollar, or U.S. yields fall the trade can go from moneymaker to money loser VERY quickly.

The biggest problem today is the yen rising in value by about 5% in recent days. That may seem small, but it’s the most important factor in this trade and can put traders underwater very quickly.

Liquidation Contagion

We haven’t used the word contagion much recently, but it may come out again.

As the yen carry trade unwinds, it’s likely to take some unexpected players with it. Maybe that’s a big hedge fund or a family office or even a sovereign wealth fund.

Whoever it is, if they’re liquidated, it’s not just the Yen Carry Trade that will need to be sold.

Stocks will be sold.

Bonds will be sold.

Private company stakes will be sold.

Everything gets dumped.

Sometimes this is quick and the market gets back to normal in a few days.

Sometimes it lasts for years because there’s some kind of rot found in the market. Remember the Great Financial Crisis that started unwinding in over-leveraged condos?

This is why it’s important to research stocks we want to own long-term. Buying opportunities and panics can come at a moment’s notice. If the fall continues, I’ll do some more buying, and premium subscribers will learn what I buy first.

Disclaimer: Asymmetric Investing provides analysis and research but DOES NOT provide individual financial advice. Travis Hoium may have a position in some of the stocks mentioned. All content is for informational purposes only. Asymmetric Investing is not a registered investment, legal, or tax advisor or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.