August 2024

Market Commentary

The Yen Carry Trade Causes Market Volatility
(4 min read)

July and August are often volatile months for markets and exaggerated by the lack of liquidity during the holiday season.

Short term market traders would often say “Sell in May and go away, come back on St Legers day”. Over the last few months markets have experienced some not unusual gyrations with global equities; the MSCI World index from peak to trough has fallen -8% and technology stocks have suffered even larger falls due to stretched valuations. Some commentators think the recent market movements have been due to concerns over a US recession as economic data has disappointed with a cooling of the labour market. The US Federal Reserve is expected to follow the European and UK central banks in cutting interest rates at its next meeting in September.

The main reason for the recent volatility, however, is the unwinding of the Japanese yen “carry trade” - for years speculators have been able to borrow in Japanese yen at zero cost and invest elsewhere with potentially higher returns. The chart below illustrates that the Bank of Japan has kept interest rates at, or very close to, zero for over 25 years as policy makers in Japan have been fighting the deflationary forces caused by the bursting of the asset bubble - the stock and property markets - in the late 1980’s.

Inflation in Japan, like everywhere else, has been increasing over the last couple of years and currently stands at 2.80% and with interest rates at 0.25% real yields remain in negative territory. With inflation ‘normalising’ in Japan, policy makers have been preparing the markets for a rise in interest rates. As the cost of borrowing increases in yen terms investors and speculators unwind that carry trade and reduce exposure to ‘risk’ assets. As Japanese and US interest rates start to move in opposite directions, more of this unwind could occur but, as always with market uncertainty, this creates opportunity.

Our client portfolios have weathered this particular storm relatively well and have minimal exposure to Japan.

Peter Geikie-Cobb | Head of Investment Research
Montgomery Associates
August 2024

Japan Interest Rates over 51 years (1973-2024)
Source: Trading Economics (https://tradingeconomics.com/)

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