SUMMARY
- The carry trade strategy involves borrowing Japanese yen at a 0% interest rate and investing in higher-yielding assets abroad to earn a profit. The success of this strategy hinges on maintaining low borrowing rates, having valuable collateral, and ensuring the profitability of the acquired assets. The Bank of Japan has started to tighten monetary policy, including rate hikes, to control inflation. This shift jeopardizes the foundational assumptions of the carry trade.
- The potential rate hikes have already strengthened the yen, increasing the cost of borrowing and exerting upward pressure on its value. This is problematic for a country like Japan that heavily relies on imports and is facing challenges due to a previously weak yen. Carry traders are finding themselves in a precarious position as they now face increased loan repayment costs in USD due to the yen’s appreciation. This unexpected shift has forced some traders to liquidate their assets to repay their yen-denominated loans, reflecting a widespread miscalculation that Japan’s interest rates would remain at zero indefinitely.
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