Yen Carry Trade - what could possibly go wrong?
Most readers will have heard of or be aware of the ‘Yen Carry Trade’. On the face of it, a fairly straightforward and profitable trade, until it isn’t.
In the simplest of terms, Japan, the world’s third largest economy has debt of over 230% of the country’s GDP. Japan can afford to service this debt because Yen interest rates have been next to zero for many years. The Dollar on the other hand has debt of approximately half of this percentage, but interest rates are some distance above zero, and so the interest cost of this debt alone costs over $100 billion each year, more than the country’s entire defence budget. The carry trade involves borrowing in Yen at very low interest rates and investing in Dollar bonds at higher rates. So what can possibly go wrong? The Yen could strengthen against the Dollar making it more expensive for Dollar investors to repay the loans, or Yen interest rates could rise to levels that decrease or even remove the trade’s margin of profitability.
Japan’s benchmark short term interest rate remained near zero between 2016 until early 2024, when in response to rising inflation the rate rose gradually to its current 0.5% level. With US dollar rates still much higher, what is the problem? The problem is the inexorable rise in Japanese longer term bond interest rates, where the 10-year bond yield has risen to over 1.8% and the 30 years over 3%. Not only does this threaten to extinguish the profit margin from the carry trade, Japanese investors are also selling US Treasuries in order to bring their cash home to benefit from the higher domestic rates on offer. As the largest overseas investors in US Treasuries, this has serious implications for overseas demand for Treasuries that has kept US interest rates low and the Dollar strong.
This is not the only emerging threat to the world economy, but it promises to be one of the more serious. Prime Minister Sanae Takaichi's government has adopted a softer stance on fiscal discipline, and her equivalent of Trump’s ‘Big Beautiful Bill’ has spooked the bond markets and pushed yields higher. This issue has been lurking among the ‘known unknown’ capital market risks for some years, but the Yen’s zero interest rate era is at an end, along with the carry trade. The extent of any contagion through other bond markets remains to be seen.
About the author
Jo Welman had a career in the City spanning 45 years and worked in a wide variety of financial sectors. After graduating from Exeter University in 1979 with a degree in economics, Jo spent ten years at Baring Asset Management where he managed a range of UK and US pension funds and unit trusts, investing across multiple sectors including bonds, international equities, commercial and residential property and private equity.
In 1989 Jo became Managing Director of merchant bank Rea Brothers’ institutional and private wealth investment management division. Over the following decade Jo launched a series of specialist investment trusts and funds in a variety of industry and property sectors, before forming a joint venture with reinsurance broker Benfields (now Aon Benfield) and raising one of the first limited liability corporate capital vehicles for the Lloyds insurance market in 1993. As part of his long-standing involvement in the insurance industry, Jo co-founded the Benfield Re-Insurance Investment Trust plc (Brit) in 1995. Following the sale of Rea to Close Brothers in 1999 Jo became Chairman of Brit Insurance Holdings Plc and in 2001, in partnership with Brit and Benfields, he co- founded specialist asset management firm, EPIC Investment Partners (EPIC).
Jo continues to provide corporate finance and investment advice to entrepreneurs and private investors. He sits on the board as a non- executive director of ARK Syndicate Underwriting
“Feet up by the pool”
Jo does not receive any remuneration for his EPIC commentary. Instead, EPIC is pleased to promote the latest edition of his book “Feet up by the pool”.
Profits from sales of the book go to The Money Charity, a charity that shares Jo’s objective to help fill in some of the worrying gaps in the school curriculum. These omissions leave many young adults lacking in the financial awareness that they need to survive in a world where they will rely on their own savings if they are ever to stop working. Even if they earn the right to a full State Pension, today this amount hardly covers council tax and utility bills, and so they need to save and build up a sum of capital amounting to around twenty times their desired retirement income. A frightening number.
As Jo eloquently says, “If we can do our bit to raise awareness of the impending UK saving and pensions crisis, the exercise will have been worthwhile.”