So you’ve probably seen that markets have been taking a pounding.

And no doubt you’ll have heard about the ‘Yen carry trade’.

No?

OK, let me explain.

This trade involves someone borrowing in a currency where interest rates are low, and then using it to invest in a currency where interest rates are higher.

Now, because of Japan’s ridiculously low interest rate, people have been borrowing huge amounts of Yen.. and investing that where rates have been higher, such as the US.

Why does this work?

Because you’re paying low interest on your borrowings (and in Japan’s case even getting paid for them), but getting higher interest rates paid out to you on your investments.

Imagine if you borrowed from the bank at 1%, and lent it to your friend Ryan at 5%, then you’d have a 4% net profit.

And “carry” is a finance bro term meaning the returns you get from a currency whilst holding it.

So in simple terms, you:

1) Borrow Yen (low interest rate)
2) Convert it into US Dollars (high interest rate)
3) Invest US Dollars into high yield assets such as bonds
4) Profit from the difference

Make sense so far?

Good!

Now, what happens when interest rates in the borrowed currency go up?

Well, suddenly that ruins the carry trade and stuffs a load of people.

The Bank of Japan raised interest rates, which meant people started covering their shorts on Yen.

This meant the US Dollar against the Yen tanked. And then more people had to cover their trades.

Because people are covering their trades and/or losing money, they had to sell their positions elsewhere. Hence why we’ve got US tech stocks dumping.

As well as that, some old dude called Warren Buffett sold down 50% of his stake in Apple.

Buffett’s Berkshire Hathaway now holds a record $277 billion and he’s started buying Treasury Bills.

These are backed by the Federal Reserve and by buying these he clearly thinks he can’t get better returns elsewhere at the moment, and is happy to wait.

Plus, fears of a recession were stoked when the Nonfarm Payroll Report (NFP) rose higher than expected.

A spike in unemployment is never good news and is known as the Sahm Rule (after former Federal Reserve economist Claudia Sahn) – it’s one of the key reports people look at when surveying the health of the economy.

And finally, the narrative for AI has shifted. Narratives drive markets.

And whilst the narrative was that AI was the best thing ever, questions are now being asked if AI is actually as good as everyone thinks. It needs to be, because the amount of money being sunk into this is huge.

For example, Microsoft invested $19 billion in the last quarter on both cloud and AI expenses. The company has made it clear it’s going to spend more than ever before on a technology.

To get an idea of this huge number, Microsoft made $22.04 billion in profits in Q2 2024. AI spend is “nearly all of our total capital expenditures” according to a previous Microsoft earnings call.  

Oh, and one more thing.

Nvidia reportedly told Microsoft that its next-gen Blackwell chips will be delayed by three months due to unspecified flaw designs.

These chips were designed primarily for speeding up AI tasks. And a three-month delay could easily become longer. Semiconductor issues are extremely technical and so the market is now worried that a three-month delay could easily become even longer.

Elliott Management, which has $70 billion on assets under management, told investors that AI was “overhyped” and Nvidia a “bubble”.

So right now, the honeymoon period for AI seems to be over. That’s the new narrative.

And that’s why the market has tanked.

So now you know! And if anyone asks, they’ll think you’re super clued up.

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