The carry trade coming to an end? How US stocks could be severely damaged by the yen in Japan
The yen exchange rate is the primary force behind global markets, according to a financial historian who cautioned that individuals who are "entirely focusing on U.S. domestic factors in trying to analyze price outcomes" should be concerned about this tendency.
"The now clear susceptibility of US equity prices to a rise in the Japanese exchange rate cautions of potential consequences for US asset prices and developed-world market prices in general from economic changes in the east," Napier said on Tuesday.
As an illustration, he pointed to the recent surge in the value of the Japanese yen, which caused prices of US stocks to fall while yields on US government debt kept falling due to selling pressure from investors looking to pay off their yen debt.
Investors have been given a preview of the potential effects of a shift in Japanese monetary policy on the U.S. financial markets, according to Russell Napier, co-founder of the investment research portal ERIC, in a recent edition of his "Solid Ground" macro strategy report.
Many market players were taken aback by the yen's rapid rebound, and stocks are currently in a general bear market.
As of Friday, the Japanese yen was trading at 148.84 against the US dollar, up around 8% from the previous month. In comparison, the yen dropped to 161.96 per dollar for the first period since December 1986 in the lead-up to the American Independence Day vacation.
A collapse in the carry trade
As worries about a worsening economic outlook were stoked by fresh data, U.S. stocks began the month significantly lower. On Thursday, the S&P 500 dropped 1.4%, the Nasdaq Composite sank 2.3%, and the Dow Jones Industrial Average dropped over 500 points, or 1.2%.
Research company BMI's Cedric Chehab, global head of national risk, stated on Friday that a number of factors have been active during the previous ten or so days. But he said that at this time of year, "corrections like this are absolutely normal."
Early warning system
Napier added that investors in yen carry trades would probably face serious consequences from the recent decline in US stocks."The carry trade investors will be forced to sell at the same time that Japan's financial institutions are forced to sell in order for buying [Japanese government bonds] as instructed by the Japanese authorities, which will exacerbate this negative reaction of US equity prices in a financial repression," Napier predicted.
In conclusion, Napier stated that the recent fluctuations in the value of the yen and their effect on the price of U.S. stocks "provides some early warning indicator of the scale of the difficulty for the US in sustaining the unsustainable when foreign investors enter a period of capital evacuation to a domestic market which will probably last over a decade!"
