Investing.com — Selling Japanese government bonds to buy riskier assets like stocks or emerging market bonds has been a popular trade for years, but the yen carry trade could be nearing an end, potentially setting off a chain of could trigger events that could leave a major dent in the stock.
The BoJ’s two-decade regime of low interest rates sent the yen carry trade red hot: traders borrowed Japanese government bonds, or JGBs, like the 10-year JGB, to short or sell, at a price that resembled the yield of the bond, which was low, and used the proceeds from the Japanese yen sale to buy riskier assets with higher returns than comparable stocks, earning a tidy profit or spread.
As with most short selling positions, the risk is always an unexpected increase in the short position; that risk, once benign, is starting to increase and that could ultimately be bad news for risky assets like stocks.
“The carry trade in the yen has been used over the years to finance bull markets in virtually every asset,” … and if it “begins to reverse, it will have negative consequences for equities and other risky assets,” Kinsale Trading said in its Sevens Report published on Friday.
The yen has appreciated more than 5% against the dollar in a month, fueling fears that the yen carry trade is nearing an end. This is mainly due to the BOJ’s intervention to support the yen, but there are other factors that are likely to push the yen higher, including expectations of faster rate cuts from the Fed.
“If the Fed takes a surprising dovish approach (and even cuts rates in July), that will cause the yen to strengthen against the dollar and that could put an end to the carry trade in the yen,” said Kinsale Trading .
Meanwhile, the political winds of change in the US could also play a role in unwinding the carry trade.
“Given that it is an election year, there is a possibility that markets will become more concerned about the US fiscal path,” fueling safe-haven demand for Japanese government bonds and a decline in the dollar may also “unwind the carry trading in the yen”. it added.
