The Currency Trade That Crashed Global Markets

The Aftermath of the USDJPY Standoff

Our April edition of the Rake Review included an educational piece on the standoff between the US Dollar and the Japanese Yen. Months ago, the Yen was at 30 year highs of 160 with interest rates of 0%. As predicted, an intervention occurred as the Yen was beginning to reach an unsustainable level.

The low interest rates led to carry trades on the Yen by foreign inventors. A carry trade refers to borrowing a currency at a low interest rate and re investing into a currency or financial asset that provides a higher rate of return. The Bank of Japan has held negative interest rates for the Japanese since 2016, giving foreign investors the opportunity to conduct a carry trade through the Yen. However, the recent interest rate hikes by the BOJ had foreign investors panicking.

The unexpected rate hike to end July saw foreign investors scramble to repay the borrowed Yen by selling off the assets that were bought with these borrowed funds. The sale of the assets led to markets cascading, and experienced some of the largest amounts of liquidations and money wiped out of the market since Covid.

$2.9 Trillion was wiped out of the stock market and almost $1.1 billion dollars of leveraged crypto positions were liquidated all within 24 hours amid recession fears. Over these 24 hours, the S&P 500 fell approximately 4%, one of the worst days for the stock market in the last four years.

$2.9 Trillion wiped out of the Stock Market, Source: @RadarHits via X

Is the US in a Recession?

Whilst investors rushed to repay their borrowed Yen, US unemployment numbers were released. It was forecasted that the unemployment rate would be 4.1%, whilst the actual rate turned out to be 4.3%. This unexpected rise in unemployment triggered the ‘Sahm Rule’, one of many recession indicators. The Sahm Rule indicates a recession has started when the three-month moving average of the US unemployment rate is 0.5 percentage points or more above its lowest during the previous 12 months. The current 12 month low is 3.8%, with the recent increase to 4.3% thus meaning the 0.5% increase from the low has been fulfilled. Hence, the mass panic sell off and calls for an emergency US Federal Reserve meeting to deal with the potential recession.

The interplay between the US Dollar and the Japanese Yen has significantly impacted global financial stability. The Bank of Japan's unexpected interest rate hike led to substantial asset liquidations and market sell offs, while rising US unemployment rates triggered the Sahm Rule, signalling a potential recession. Although markets have seen some positive recovery, further downside risks remain. Our Rake Review will continue to monitor these developments, providing insights to keep you informed and prepared for what lies ahead.

Written by Alexandar Artis

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