As global stock markets plunged on Monday, financial analysts pointed to an esoteric trade involving the Japanese yen as a key factor for the decline. Markets have since rebounded but, with volatility surging and investors feeling skittish, there are fears that the unwinding of the yen-based “carry trade”—which describes profiting off interest rate spreads across different currencies—could drive further losses.
The popularity of the Japanese carry trade is easy to understand. While central banks such as the Federal Reserve increased interest rates in the face of inflation, the Bank of Japan kept its interest rate near zero—or even lower—to incentivize economic growth. As a result, investors such as hedge funds would borrow the yen on the cheap to move into assets with higher growth potential, such as U.S. Treasuries, stocks, and other currencies. “It’s one of these trades that was a no-brainer for a lot of people,” said Chester Ntonifor, a foreign exchange strategist for BCA Research, in an interview with Fortune.
