-A market-wide sell-off has spread around the world, with US stock indexes falling 3% and the cryptocurrency market cap falling 11% in the past 48 hours.
-Impact of Bank of Japan (BoJ) raising interest rates
-One factor driving the contraction in global markets is the Bank of Japan (BoJ) raising interest rates and its impact on a popular investment strategy known as carry trading. Carry trading is when an investor borrows a low-interest-bearing currency, such as the Japanese yen, and reinvests the borrowed currency in a higher-interest-bearing currency, such as the US dollar (USD).
-Interest Rate Carry Trading Strategy
For many years, investors would borrow yen at low interest rates, such as ≈0.4%, and use the borrowed yen as a form of leverage. They would convert yen into US dollars (or other strong, high-yielding currencies) and hold the margin almost for free. This arbitrage was possible because of the large spread between low yen borrowing rates and high US dollar interest rates.
-BoJ interest rate change
However, after the BoJ raised interest rates last week from 0-0.1% to ≈0.25%, essentially ending its negative interest rate policy, the Japanese yen interest rate carry trade became significantly less attractive, causing many investors to unwind their positions.
-Impact on the market
As investors repay the yen they borrowed, the yen has appreciated against the dollar, with USD/JPY just hitting its lowest level since 2023. As the yen strengthens, many yen-denominated carry trades will be subject to margin calls and the underlying assets will be sold, causing severe disruption to global markets. The era of free yen lending is coming to an end.
-Implications for the cryptocurrency market
Cryptocurrencies are still riskier than US stocks, and as such, a decline in traditional markets often leads to a larger decline in the crypto market. With recent high unemployment figures, stubborn inflation, geopolitical uncertainty, and the fallout from the upcoming yen carry trade cancellation, we could be in for some turbulence ahead.
-Conclude
The BoJ’s rate hike has dramatically changed the dynamics of the Japanese yen carry trade, causing a large unwinding of positions from investors and impacting global markets. This volatility could continue to impact both traditional and crypto markets in the near term.