Japan’s Surprise Attack on the West’s Stockmarkets – Fat Tail Daily

In today’s Fat Tail Daily, for decades, the Japanese funded our soaring stockmarkets and government deficits. They called it the ‘yen carry trade’…until it blew up on Friday.

On Friday, the Japanese finally decided they’ve had enough of overtourism. The yen spiked and unleashed chaos across global financial markets.

But why?

The yen’s weakness has been diverting tourists into Japan for years now. A lot of that was the Bank of Japan’s doing. It kept interest rates so low that the yen couldn’t catch a bid.

Between 2011 and June 2024, the yen halved against the US dollar.

But a tourism boom wasn’t the only effect of a cheap yen and even cheaper Japanese interest rates.

Did you know that for decades Japanese monetary policy has been funding our soaring stockmarkets, and government deficits?

They call it the ‘yen carry trade’. And its reversal is what triggered the market chaos this week.

Is this the end of one of the most powerful forces driving financial markets higher? Or just a hiccup?

I can do something few others can’t on this…and that’s report from inside Japan.

Yep…I’m right on the front line.

So, let’s take a closer look at how the yen carry trade works to find out what you need to know…

Interest rates in Japan have remained near zero for decades. So clever hedge fund managers borrowed in yen and invested the proceeds in dollars, euros and pounds. The idea is to pocket the difference in interest rates.

That’s how it began. But soon Japanese money was flowing into other assets.

It worked so well that just about anyone capable of borrowing in yen jumped on the trend.

One Texan hedge fund manager even got a Japanese mortgage on his American home.

His theory was that low interest rates and a plunging yen would make the debt cheap to repay. And boy was he right given the yen tanked…

But this flood of almost free money bid up asset prices everywhere.

The yen became the source of not just free debt, but free profit! Interest rates were so low in Japan and so much higher elsewhere that any fool could make a killing by profiting from the difference.

There was just one problem…

This turned all markets into a giant
punt on the yen

While the yen’s value on foreign exchange markets fell, the yen carry trade worked well on all three counts:

1. Investors paid a low interest rate on their Japanese borrowings
2. Investors pocketed high returns by investing the money outside of Japan
3. And the falling yen made it even cheaper to repay the debt when the time came to sell out

But a fall in the yen isn’t great news for everyone…especially the Japanese consumers. It caused inflation to rear its ugly head in Japan for the first time in decades.

And so, the Bank of Japan began to intervene in the yen in 2022.

Some called it the ‘yentervention’. The idea was to arrest the plunging value of the Japanese currency.

But in July 2024 the yen turned a corner. The value of the yen began to rise, quickly. And then, on Friday and Monday, it soared out of control.

Starting on 11 July, the yen has now surged 13%.

This jump in the yen undermined the yen carry trade by making it 13% more expensive for foreigners to repay their rather large Japanese debts.

And so, the yen carry trade began to unwind in two ways.

Investors sold their Western stocks and bonds in a panic to repay yen denominated loans. This undermined stocks and bonds in the West and bid up the yen even more as the money flowed into Japan to pay off loans.

Second, those who were planning to borrow yen to buy Western assets changed their mind, undermining the demand for stocks and bonds too.

A surge in sellers and a drop in buyers was always going to undermine prices.

What do the Japanese think?

Strangely enough, the stock market chaos has barely featured in the news here.

A national high school baseball competition and US politics ranked higher on the agenda.

That’s because Japanese people aren’t as obsessed with stock markets as we are. Not anymore, anyway.

Too many people committed suicide when the Japanese stock and property bubble burst in 1990. Then came 30 years of deflation. This and more killed the vibe for playing the stock market for most of the locals.

Who knows where the yen goes from here?

One thing I can tell my Japanese friends is that some sort of allocation to gold would’ve helped protect them when the yen was tanking.

That was a way for Japanese investors to benefit from a weak yen in the some way American hedge fund managers did.

The same is true in Australia. The Aussie dollar is a long way from its glory days of being above parity with the US dollar.

But gold in Aussie dollars is at a record high. This is an enormous tailwind for Aussie gold stocks.

I can tell you that Japan doesn’t have a gold mining industry like we do.

Make the most of Australia’s bounty, I say.

For more on this opportunity, go here now.

Until next time,

Nick Hubble,
Editor, Strategic Intelligence Australia

All advice is general advice and has not taken into account your personal circumstances.

Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

Nick Hubble found us at Fat Tail Investment Research in 2010 after a stint inside Wall Street’s most notorious bank, Goldman Sachs, during the 2008 GFC. That’s where he saw the true nature of the investment banking business. Since then, he’s been the editor of the Daily Reckoning Australia and the UK-based Fortune & Freedom and Gold Stock Fortunes.

He’s delighted to work as Investment Director and Editor for Jim Rickards’ Strategic Intelligence Australia. Here he helps turn Jim’s big-picture views into specific actionable advice and ideas for Australian investors.