About the Author(s)
Eman Fatima is currently pursuing her Bachelor’s degree in International Relations from Government College University Lahore. She has keen interest in understanding complexities of global politics and dynamics that shape international interactions.
Fears of recession, once again, everywhere. On August 2, 2024, the stock markets started showing a decline . Fears of slowing economic development in the US were stoked by disappointing job statistics released by the US government, which caused investors to sell heavily in the domestic stock market. When the US sneezes, the world catches a cold, is the phrase used worldwide to demonstrate how a decline in US markets causes trouble for the rest of the world. But now the Bank of Japan is playing a significant role in accelerating the stock market crash, apparently in Asia. This is evident in the global stock markets that plummeted on August 5, 2024, led by sharp declines in Asia. Markets were already jittery before Monday’s rout due to fears of a US recession, caution over the AI hype, and geopolitical tensions in the Middle East. But, as Tony Sycamore, an analyst at IG Australia, told that it was the Bank of Japan’s interest rate hike on July 31 that was “the straw that broke the camel’s back.”
What is yen carry trade?
The world has been facing a lot of inflation except for Japan. The inflation there has been stagnated since the 90’s and Japan faces issues of deflation. When a central bank raises interest rates, borrowing becomes more expensive. This tends to reduce consumer spending and business investment, leading to lower demand for goods and services. As demand falls, upward pressure on prices decreases, helping to control inflation. So while the rest of the world was raising interest rates to combat inflation, Japan was cutting interest rates to combat deflation. This low interest rate in Japan accelerated yen carry trade. Yen carry trade is an investment strategy where investors borrow money in a yen with low interest rates and invest in a currency with high interest rates of returns, such as the US dollar. Japan has historically had very low or even negative interest rate so the cost of borrowing yen is very low. Investors then convert this borrowed yen into US dollars or Australian dollars and invest in bonds, stocks, or real estate. The US Treasury bonds are always in high demand. This means that investors lend money to the government, and the government promises to pay off the money with an interest rate that is 3.7%. So the difference between the low borrowing cost in yen and the higher returns from the investments is the profit. But now the situation is reversed.
The BOJ, on July 31, 2024, decided to increase the interest rates from 0% to 0.25% to combat inflation. Many scenarios are attached to it. Rising interest rates have increased the value of yen currency, making borrowing more expensive. Due to this, investors are move away from yen carry trade. The correct size of the Yen carry trade is not know, but it is believed that it carries hundreds of billions of dollars worth of investments. The Japanese investors are large in number worldwide, so they affect significantly the global stock markets.
How is the ripple effect happening?
Though the interest rate has increased in Japan, there are expectations that it will be increased further. This unstable condition has led the investors not to borrow yen. With no money in hand, investors are bound to refrain from investing in stock markets and not to buy shares. This decrease in demands has caused a significant decline in stock market shares worldwide that is evident on August 5, 2024, because Japanese investors and investors investing through yen are very high in number all over the world. Japanese stocks suffered their biggest ever daily loss Monday. The Nikkei 225 index in Tokyo closed more than 12% lower. The Dow opened more than 1,000 points lower, the S&P 500 was down 4.25%, and the Nasdaq Composite plunged by more than 6%. Sensex and Nifty 50 witnessed a heavy sell-off on Monday. South Korea’s Kospi also marked a grim milestone on August 5 after closing 8.8% lower. Its losses were so huge that trading halts kicked in. The Kospi’s decline was its biggest percentage decline since October 24, 2008, during the Global Financial Crisis. Taiwan’s benchmark Taiex stock index closed 8.4% lower in its worst day since 1967, when trading started. Among the sea of red in Asia, Australia’s ASX 200 index appeared less bruised. The benchmark Australian index closed 3.7% lower, but still marked its largest one-day decline since May 2020. Bitcoin tumbled 15% overnight to below $50,000. The declines marked the crypto currency’s lowest point since January and its biggest drop in a single day since November 2022. Europe showed no signs of avoiding the chaos as markets opened on Monday morning. The Stoxx 600 fell by more than 3% overnight to its lowest point since January.
As the yen was only the interest free currency, it was used widely to buy shares, bonds or assets in the USA. But now there are chances of fewer investments in the USA and an increase in interest rates. With the dollar becoming more expensive, global trade is bound to shift towards imbalance. When the US sneezes, the world catches a cold. So the rise in interest rates in the USA means more inflation worldwide. Japanese investors hold large amounts of US Treasury bonds. Japanese increased interest rates might instigate investors to sell US bonds to invest more in Japanese assets, as the Federal Reserve of America has announced to cut interest rates in September to counter the slow manufacturing and economic growth. This selling can cause US bond prices to fall and yields to rise. The high yield can wipe out the efforts of the Federal Reserve to cut interest rates. This can slow down economic growth, leading to lower corporate profits and thus lower stock prices. If investors believe that the BOJ’s rate hikes will slow global economic activity, they may become more cautious and sell off stocks, leading to price declines. With the increase in yen value, the goods of Japan are expected to be more expensive for countries to buy, potentially reducing sales for Japanese exporters and also effecting countries dependent of Japanese goods.
The BoJ’s decisions to hike interest rates affect global markets and stock prices by altering investment behaviors, impacting currency values, influencing bond yields, and raising concerns about economic growth. These interconnected effects lead to shifts in capital flows and investor sentiment, causing fluctuations in stock prices worldwide.
