For nearly thirty years, extremely low interest rates in Japan have made the yen one of the world’s most important funding currencies. Investors have borrowed cheap yen and invested the money in higher-yielding assets around the world. But as the Bank of Japan raises interest rates, could this huge flow of money begin to reverse?In this episode, Skip Montreux and Samantha Vega explain how the Japanese yen carry trade works, why it has helped support global financial markets, and why changes in Japanese monetary policy could create serious risks for investors around the world.
Skip and Samantha start by explaining the basic idea behind a carry trade. Investors borrow money in a currency with a very low interest rate — the funding currency — and then invest that money in currencies or assets offering a higher yield. For decades, Japan’s rock-bottom interest rates have made the yen an attractive currency to borrow.They then look at where this borrowed money goes. Carry trade investors can put their capital into higher-yielding currencies, government and corporate bonds, global equities, real estate, and other assets. Large institutional investors can also use leverage and foreign exchange derivatives to amplify relatively small differences in interest rates.Next, Skip and Samantha discuss why the Bank of Japan is changing the situation. After years of extremely low and sometimes negative interest rates, the BOJ has begun raising rates as Japan moves away from its long period of deflation. Higher Japanese interest rates make borrowing yen more expensive and reduce the potential profit from the carry trade. They also look at Japan’s enormous retail foreign exchange market and the financial nickname ‘Mrs. Watanabe’.The yen carry trade is based on a simple idea: borrow money cheaply in Japan and invest it somewhere that offers a higher return. But after decades of extremely low Japanese interest rates, that system is beginning to change. As borrowing costs rise and currency markets become more unstable, investors may need to reduce or unwind their positions.Because so much Japanese capital has flowed into global financial markets, what happens to the yen does not stay in Japan. A major change in the carry trade could affect bonds, equities, currencies, and borrowing costs around the world.Do you like what you hear?Become a D2B Member today for to access to member-only episodes, our -- NEW!!! -- INTERACTIVE AUDIO SCRIPTS, PDF Audio Script Library, Bonus Vocabulary episodes, and D2B Member-only episodes.Visit d2benglish.com/membership for more information.