Yen: The Next Investment Wave

What‘s the Yen Got to Do With It?

“What does the Yen have to do with my investment and retirement portfolio?”

Many financial advisors may be hearing this question from their clients in the next few weeks. 

Why?  Well, believe it or not, the Japanese Yen has been very important in creating global wealth in the last three (3) or so decades. 

How?  Well, there’s a thing called the Yen Carry trade—and if you haven’t heard of it yet, it may start popping up quite a bit in the next few weeks.

Michael Gayed of Lead Lag Reports sums up that the Yen Carry trade is better than most. Here’s what he said in a recent missive:

For decades, Japan has been the source of tremendous leverage for the global financial system due to what’s known as the carry trade. The Japanese carry trade involves borrowing Japanese yen and investing the borrowed funds into assets with higher yields, often in different countries.

When traders engage in the carry trade, they often purchase higher-yielding assets, such as foreign equities, which can drive up stock prices in those markets due to increased demand.

Conversely, if the carry trade unwinds — often due to a sudden increase in Japanese interest rates, a surge in yen short covering, or times of financial stress — it can lead to a swift selloff in those assets, including stocks, as traders rush to cover their yen borrowings. This can result in increased volatility and downward pressure on global stock markets, illustrating how interconnected financial strategies can have far-reaching effects.”

Why do I bring this to your attention? 

Because, as we’ve all been enjoying the start of spring, the Bank of Japan has begun raising their interest rates—and the Yen Carry trade has started to unwind. This change in posturing has caused the Bank of Japan to step in this week with currency interventions.  According to Michael Gayed, here is why that is concerning to global equity markets:

“Now, because of the most recent yen movement and subsequent intervention by the Bank of Japan, Pandora’s Box may have opened.

Recall that the key to my argument all along was that the Bank of Japan would, at some point, be forced to save the yen from depreciating against the dollar. This is because the weaker the yen gets, the more expensive oil priced in yen becomes. And because Japan imports all its oil, the risk becomes severe cost push inflationary pressure.

The Bank of Japan can undertake a series of monetary policy actions to strengthen the yen. These include tightening monetary policy by raising interest rates, which can attract foreign investment due to higher returns, thus increasing demand for the yen. In practice, this is nearly impossible to do given high interest rate differentials. The BoJ could also intervene directly in the foreign exchange market, buying yen and selling foreign currencies to increase its value. Additionally, the BoJ might look to reduce its balance sheet by selling government bonds, which would decrease the money supply and could lead to a stronger yen.

However, the central bank must carefully consider these potential actions as they could have significant impacts on the Japanese economy, potentially slowing growth or affecting inflation rates. The latter of which becomes a very serious problem.

Either way, the point remains the same. We are at the point in the story where the BoJ must act, and the impact could be far more consequential than anyone can imagine.”

Why does this matter, and how can you benefit from this knowledge?

The change in global inflation and the rising of interest rates across almost every industrialized country since 2022 is a major structural change to global liquidity—and liquidity is what drives all risk assets higher or lower.  These structural changes develop over the years. When they start, it takes a very large recession or reset in the economy to reverse them.

In other words, these developments add another piece of evidence to our long-running thesis that the 2020s will end up looking a lot like the 1970s with every sign of stagflation.

If our thesis is right, and if you are an investor who appreciates catching the next wave as it develops, then watching the reactions in U.S. Interest Rates, Metals, Miners, and Energy related investments is probably where this knowledge can best be put to work, as these trends tend to support hard assets and threaten leveraged risk assets like Tech stocks or Treasuries.

Curious to learn how you can benefit from The Yen Carry Trade? Click here to start a conversation.