06/08/2024
*Forwarded But nicely nicely articulated*
Yen carry trade and its impact on returns:
For 30 plus years, Japan had zero interest rates with a stable but declining currency. Investors borrowed money from Japan and invested in high yielding assets across the world. Basically- they were short on the Yen.
All of a sudden, with an increase in interest rates from 0 to 0.25%, investors rushed to buy the yen to cover their shorts and the Yen moved from 165 to 145 per USD.
If an investor borrowed 16500 Yen to buy $100, now he needs $113 to repay the loan. A loss of 13% without a move in the price of the base asset!!!
So the investor sells assets to avoid further loss. The asset price comes down compounding the loss. This cycle continues until either the investor goes bankrupt or gets cheap money from somewhere else to repay the loan in Yen.
Imagine this happening for $4tn worth of Yen loans!!!
Situation ahead - either US cuts rates to soothe the markets or allows the markets to fall to a level where some of the carry trade is unwound.
Given the current situation in the US, the second scenario looks more likely where markets will fall further before stability comes. Hopefully, India will not be as badly hurt as the other markets because of the domestic money waiting to be deployed. The initial fall will trigger margin calls but when large trades are squared off, the market will move into a buy mode again.
On the other side, currency will come under pressure and RBI may not hike rates but will definitely not cut rates to protect the rupee from sliding. In fact, it will make adjustments to ensure that foreigners sell the rupee assets for the lowest possible amount. This will mean higher rates for longer, tougher monetary stance and effectively slowing down capex growth.
Time to move to defensive portfolios and growth style
