📉 Why is the stock market crashing?

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?