The unwinding of carry trade in the Japanese yen in the wake of its appreciation against the US dollar disrupted global markets. The Japanese yen rose as much as 2.94% intraday to 142.22 against the US dollar on Monday, hitting the highest level since Jan. 4. It was trading 2.12% lower at 143.42 a dollar as of 10:44 a.m.
The Bank of Japan, in line with market expectations, hiked its benchmark interest rate to 0.25% from its 0.0–0.1% last week. This was the second time the central bank hiked its interest rate after ending its ultra-loose policy for the first time in 17 years in March.
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The Japanese currency started to gain against the greenback since the market participants anticipated that the BoJ would shift from its ultra-loose policy in early July.
Now, the markets expect the BoJ to go for further hikes, which is strengthening the Japanese currency against the greenback, resulting in sell-off in the yen-funded carry trade.
What's Carry Trade?
Carry trade is a popular concept in the currency market, where investors borrow low-yielding currencies to invest in high-yielding currencies.
Due to the BoJ's ultra-loose policy and the weak yen, investors used the Japanese unit for carry trade widely. In a situation where the yen appreciates against the dollar, the carry trade would yield a loss. Hence, the favourite carry-trade currency's rising might prompt traders to rush to unwind their long positions in the yen, sparking a wide sell-off.
Local equities in Japan have slumped, with the benchmark Nikkei 225 falling 12.41% since last Wednesday when the BoJ delivered the hike, according to data on Bloomberg.
The dollar index slipped below the psychologically crucial 103 level in Asian trade to a day's low of 102.65, the lowest since March 11, in early Asian trade Monday as recession fears in the US rose following weaker-than-expected US Jobs data.
The dollar index was trading 0.43% lower at 102.76 as of 11:29 a.m. This has added to the Japanese yen's strength against the greenback.
Market participants are now anticipating that the US Federal Reserve may go for a more aggressive approach to loosen the monetary conditions at a time when Japan is expected to hike rates further.
The weak US economic data and a possibility of a tighter monetary policy in the east has impacted the US stocks negatively, as more investors rushed to fund their yen-debt. The S&P 500 and Nasdaq Composite settled 1.84% and 2.43% lower respectively.
The yield on the 10-year US Treasury note slipped below 4.0% level on Friday for the first time since Feb. 1, according to data available on US Department of Treasury's official website.
On Monday, the yield on the 10-year US Treasury note extended its fall to 3.72%, the lowest level since June 29, 2023. It was trading 3.73% as of 11:27 a.m.
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