The Yen Carry Trade.
Since the term seems to be on everyone's lips right now, it just might be a good time to try explaining in very simple terms on how it’s impacting stock markets all around the world.
Here's a thread.

So, what is the yen carry trade?
Let’s go back more than thirty years to understand where it all started. In the late 1980s Japan was in the midst of both a real estate and a stock market bubble. The Bank of Japan managed to burst the stock market bubble very rapidly and the real estate bubble very slowly, by raising interest rates.

After bursting the bubble by raising interest rates the Bank of Japan started cutting interest rates and soon the rates were close to 0%. This meant that anyone looking to save money by investing in fixed income investments(i.e. bonds or bank deposits) in Japan would have made next to nothing. This led to Japanese money looking for returns outside Japan.

Some housewife traders started staying up at night to trade in the European and the North American markets. They borrowed money in yen at very low interest rates, converted it into foreign currencies and invested in bonds and other fixed income instruments giving higher rates of returns than what was available in Japan. Over a period of time these housewives came to be known as Mrs Watanabes and at their peak accounted for around 30% of the foreign exchange market in Tokyo.

The trading strategy of Mrs Watanabes came to be known as the yen-carry trade and was soon being adopted by some of the biggest financial institutions in the world. A lot of the money that came into America during the dotcom bubble came through the yen-carry trade.
It was called the carry trade because investors made the carry i.e. the difference between the returns they made on their investment (in bonds or even in stocks for that matter) and the interest they paid on their borrowings in yen.

The strategy worked as long as the yen did not rise in value against other currencies, primarily the US dollar.
Let us try and understand this in some detail. In January 1995, one dollar was worth around 100 yen. At this point of time one Mrs Watanabe decided to invest one million yen in a dollar denominated asset paying a fixed interest rate of 5% per year.
She borrowed this money in yen at the rate of 1% per year. The first thing she needed to do was to convert her yen into dollars. At $1=100 yen, she got $10,000 for her million yen, assuming there were no costs of conversion.

This was invested at the rate of 5% interest. At the end of one year in January 1996, $10,000 had grown to $10,500. Mrs Watanabe decided to convert this money back into yen. At that point, one dollar was worth 106 yen. She got around 1.11 million yen ($10,500 x 106) or a return of 11%. She also needed to pay the interest of 1% on the borrowed money. Hence her overall return was 10%.
Her 5% return in dollar terms had been converted into a 10% return in yen terms because the yen had lost value against the dollar. So this was a double gain for her. The depreciating yen added to the overall return.

But let us say instead of depreciating against the dollar, as the yen actually did, it had appreciated. And let us further assume that in January 1996, one dollar was worth 95.5 yen. At this rate $10,500 that Mrs Watanabe got at the end of the year would be worth 1 million yen ($10,500 x 95.5) when converted back to yen. Hence Mrs Watanabe would end up with a loss, given that she had to pay an interest of 1% on the money she had borrowed in yen.

The point is that for the yen carry trade to be profitable the yen would have to be either stagnant against the dollar or lose value. The moment it starts to appreciate against the dollar, the returns in yen terms start to go down.
The yen carry trade worked in most years up since it started in the mid 1990s, to mid 2007. Between 2004 and mid 2007, stock markets across the emerging market rose as money through the yen carry trade route came in. This included India as well.
In June 2007, one dollar was worth 122.6 yen on an average. After this the value of the yen against the dollar started to go up and went to around 80 yen to a dollar. This had meant the death of the yen carry trade at that point of time.

This is history. What is happening now?
In the last few years, the interest rates in Japan have been next to nothing. I will not go into the details here. But these low interest rates have led to the investors borrowing in yen and investing that money across other parts of the world, including the US, where interest rates are considerably higher than Japan.

But this seems to be changing now.
The yen has been rising in value against the dollar. Last week, the Bank of Japan raised its key interest rate to 0.25% from 0-0.1%. The yen has been appreciating against the dollar factoring in this possibility from around 10-11th July onward. On 10 July, one dollar was worth around 161.6 yen. At the time of writing this, one dollar was worth 143.2 yen.
This seems to be making the yen carry trade unviable.

As explained earlier, an appreciating yen, goes against the basic idea of the yen carry trade. Hence, some of the investors who have borrowed in yen and invested in other stock markets around the world, seem to be selling out and hence, the markets have taken a beating.
This is how it works at a very simple level. Of course, the stock market is a complex being and there are other reasons at work as well. But I wanted to keep this simple.

How will it impact the Indian stock prices?
One doesn’t really know how big an investment has been made in Indian stocks through the yen carry trade route. But if a global unravelling happens pressure will be felt in India as well.
Further, the retail investors might be able to buy the selling that happens, as they have through 2024, and in the process, ensure that the stock prices don’t fall as much as they would have otherwise. But honestly I don't know how this will play out. There are too many complex factors to take into account. But Warren Buffett is sitting on a lot of cash.
And as he has said in the past: "A pin lies in wait for every bubble and when the two eventually meet, a new wave of investors learns some very old lessons."

Again, all this can’t be predicted in a clear, concise and confident manner, unless you are a financial influencer or an expert appearing on TV or a TV anchor for that matter.
I have nothing to sell you, so, as I keep repeating, diversification remains the only game in investment town, even though it seems stupid on most days, until it doesn’t.

This is the end (of this thread).
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