A popular investment strategy, known as “carry trade,” recently sent shockwaves through global stock markets as investors lost billions of dollars worldwide amid fears of an economic recession.
Carry trade is a long-used financial strategy that involves borrowing money in a currency that offers low interest rates and then investing this money to buy other stable currencies like the US dollar or in less-volatile financial markets.
Historically, Japan has been famous for keeping its interest rate at or near zero to increase economic activity in the country. However, this zero-interest rate has also attracted investors who have continued to borrow Japanese Yen and invest in US government bonds, tech stocks, and multiple avenues that are known for promising returns.
For Japan, the biggest disadvantage of offering a low interest rate was that its Yen started weakening against the US dollar, kicking off a new wave of inflation that troubled the local Japanese people.
This rising inflation urged the Bank of Japan to increase the interest rate to 0.25%, which left global investors off guard. This led to panic selling and, hence, the market decline.
This was the second time since March that the Bank of Japan increased the rate, which also worried borrowers about another possible hike in the near future, resulting in the mass exits. The upcoming interest rate cuts in the US also worried some investors, most of whom buy government bonds with Yen carry trade and forced them to take the exits after anticipating low profits in the upcoming times.
The US Labor Department report for July found the unemployment rate at a three-year high of 4.3%, further convincing investors of the economy’s deteriorating condition and urging them to exit their positions.
Financial analysts suggest that investors start liquidating their assets in such an uncertain market condition, and most often, this is a chain reaction that convinces more people to sell their stocks or put all of their money at risk.
Currently, the global markets are heading towards recovery, but some analysts believe that the worst is yet to come.
