Has the Bearish Impact of Yen Carry Trade Fully Played Out?

My points:

”I believe that short-term fluctuations may have reached a bottom, there could still be similar volatility in the medium to long term. This is especially true given the Federal Reserve's expected interest rate cuts and the Bank of Japan's gradual approach to raising interest rates.

However, the current interest rate of 0.25% by the Bank of Japan remains the lowest globally, and they have indicated a slow path towards increasing rates. It is reasonable to expect that there will be further yen carry trade closures and associated market pressures in the future.

Perhaps in similar situations, we might not need to panic and rush to sell or short-sell; it could also be a good opportunity to buy on dips.

The market performance in recent days has precisely illustrated this point. It suggests that instead of reacting with fear, a more measured approach to market volatility could reveal strategic entry points for investment.”

$Japanese Yen - main 2409(JPYmain)$ $S&P 500(.SPX)$ $NASDAQ(.IXIC)$ $SPDR S&P 500 ETF Trust(SPY)$ $Invesco QQQ(QQQ)$ $DJIA(.DJI)$

Why how the major banks like Goldman Sachs, JPMorgan, and UBS think? Below are some analysis:

I. Yen Appreciation and the Impact of Yen Carry Trade on the Global Financial Market Collapse

The stable low interest rates of the Japanese yen have historically underpinned yen-carry trade, where investors borrow yen at low interest and exchange it for foreign currencies to earn higher returns abroad.

However, on August 5th, a significant appreciation of the yen disrupted this tranquility, with the yen-to-US dollar exchange rate on the Tokyo market reaching a level of 1 US dollar for 141 yen, marking the highest yen appreciation and dollar depreciation since mid-January in about seven months.

Prior to this, on July 11th, the yen had notably appreciated against the US dollar following the release of the US June CPI, which showed easing inflation and led to expectations of a Federal Reserve rate cut. The Bank of Japan responded by buying yen and selling dollars.

Market analysts suggest that the recent and sustained appreciation of the yen directly impacts the cost and returns of yen-carry trades. "Yen speculators" may face margin calls, compelling them to close positions by selling foreign assets and buying yen to repay debts.

When such large-scale closures occur, or when overseas assets are sold and repatriated to Japan, it can lead to a decline in the exchange rates and stock prices of foreign assets.

The magnitude of this impact has been so significant that it has caused a global investor panic. To be candid, I have already liquidated my positions, while some investors bravely bottom-fished on Monday night.

Whether the global market can now emerge from this "sell-off" panic and whether such a plunge will recur are questions worth pondering. Does the opportunity for yen-carry trade still exist? Deciding whether to sell or bottom-fish on such days is a matter that requires careful consideration.

II. Has the Impact of Yen-Carry Trade Been Fully Priced In? What Do Major Banks Think?

So, what's the current situation? I've used Kimi to help me organize the viewpoints of various institutions on the yen carry trade market:

Goldman Sachs and Société Générale: Optimistic About the End of Yen Carry Trade

• Goldman Sachs: Believes that the pressure from yen short positions being closed has been largely eliminated, suggesting the market may be nearing a bottom.

Goldman Sachs' FX team's positioning scores indicate that yen short positions have been essentially liquidated, with a current stance slightly biased towards being bullish. Additionally, Goldman Sachs maintains an optimistic view of the Nikkei index, considering its fundamentals to be very attractive.

• Société Générale: Views the closing of yen carry trade positions as nearing completion, with weak US inflation data and a hawkish shift by the Bank of Japan driving a reversal in carry trades.

JPMorgan Chase, UBS, and Scotiabank: Cautiously Believe the Closing Process Has Not Yet Ended

• JPMorgan Chase: Advises investors that the closing of carry trade positions may have only reached 50-60%, and the Bank of Japan may continue to gradually raise interest rates. Further fluctuations are anticipated.

Arindam Sandilya, the co-head of foreign exchange strategy, added that the yen is still one of the most undervalued currencies. The significant short-term appreciation of the yen has caused technical damage to portfolios that is not easily repaired.

• UBS: Macro strategist James Malcolm noted that about 50% of carry trades have been closed, with approximately $200 billion of carry trades closed in the past two to three weeks.

• Scotiabank: Shaun Osborne believes that the extent to which carry trades can be closed largely depends on the level of interest rate differentials, rather than changes in the differentials.

In summary, there is a divergence of opinions among major financial institutions regarding whether the impact of yen carry trade will continue to influence the global financial markets.

III. What Are the Expectations for Future Interest Rate Hikes by the Bank of Japan?

The expectations for interest rate hikes by the Bank of Japan (BoJ) are generally believed to be dependent on inflation risks and economic conditions, with a gradual adjustment of interest rates by the central bank. However, Citigroup offers an intriguing perspective.

• JPMorgan Chase: It anticipates that the BoJ may continue to gradually increase interest rates, as the country's borrowing costs have not yet reached a level that matches the real economy.

• Nomura Holdings: It considers the timing of the BoJ's interest rate hike to be appropriate, implying that further rate hikes are likely.

• Citigroup: It points out that achieving a threshold level of the U.S.-Japan interest rate differential may require three rate cuts by the Federal Reserve, a process that could take about six months. This would indirectly affect the pace of interest rate hikes in Japan.

IV. Impact of Future Yen Exchange Rate Movements

• Foreign Exchange Market: The expectation of yen appreciation could potentially trigger more carry trade closures, leading to a decrease in the USD/JPY exchange rate. Additionally, if the Federal Reserve enacts interest rate cuts, it may narrow the interest rate gap between the U.S. and Japan, thereby influencing the yen's exchange rate.

• U.S. Stock Market: Goldman Sachs and Société Générale believe that the performance of the U.S. stock market, especially technology stocks, represents the greatest threat to market stability. Continued market decline could impact the U.S. economy and the Federal Reserve's policy decisions.

• Bitcoin and Other Cryptocurrencies: The cryptocurrency market is typically sensitive to global liquidity and risk sentiment. The closure of yen carry trades and changes in the U.S.-Japan interest rate differential could affect global liquidity conditions, subsequently impacting the cryptocurrency market.