Japan recently raised its interest rate unexpectedly to push the global markets into mayhem, which resulted in panic mass selling across the world amid the fears of global recession.
The Bank of Japan’s unexpected move to tighten its monetary policy, which included raising the target interest rate on government bonds and reducing bond purchases, caused a sharp rise in the Yen’s value against the American dollar.
This abrupt change led to a rapid unwinding of Yen carry trades, where traders, businesses, and individuals hurried to pull out of the nose diving markets as fears of losing big sums of money loomed.
Carry trade is a famous financial strategy in which an investor borrows a massive amount of money at a low interest rate in one currency and uses it to invest in assets or instruments that offer a higher return in another currency. In this case, investors were borrowing money in Japanese Yen, as the Bank of Japan has mostly kept its interest rate at zero to attract global borrowers and spur economic activity.
After borrowing in Yen, businessmen would invest in stable American markets that promise high returns and favorable business environments.
However, this low interest rate also means that Yen keeps on losing its value against other currencies, particularly the United States dollar, which increases inflation for local Japanese people. This rising inflation led the Bank of Japan to raise the policy rate to 0.25%, which sent shockwaves among global investors.
Investors who found themselves unable to borrow more Yen due to the rising interest rate started exiting the US and other markets, which created pressure on the global stock exchanges.
Markets are highly sensitive to changes in investor sentiment, which means that when a large number of traders start exiting their positions, it creates panic. Other investors, seeing prices fall, also start selling their assets to avoid losses, even if they are not directly involved in the Yen carry trade. This trading pattern creates a chain reaction or a snowball effect, where selling leads to more selling, and the financial markets crumble.
As of now, the markets have started recovering and are likely to rise to the previous levels soon. However, there is a visible division among financial experts about the future of Japan’s Yen and its impact on the global markets.
Some analysts suggest that rising inflation in Japan will force the country’s central bank to further raise the interest rate somewhere in the near future, which could once again cause a bloodbath in the global stock markets. Other Wall Street Experts believe that the worst is over as businesses start entering the profit territory once again after suffering massive losses in recent days.
Compared to the interest rate in the US, which stands at more than 5%, Japan’s 0.25% rate seems miniscule from the outside. However, the ultra-reliance of investors on Japan’s low rates and the consistent approach of the country to keep the rates near zero worried investors about the country’s future monetary policy, which led to the global panic.
