On August 5, major stock markets across the world experienced their sharpest decline in decades. According to the market watchers, one of the causes behind the market mayhem was the yen carry trade.
- Global investors are always looking for opportunities to make money. Investors borrow money in a country where the interest rates are low and invest that money (after converting the currency) in a country where the interest rates are much higher. This is called a carry trade.
- Such opportunities can exist because central banks of different countries try to keep interest rates at a level that suits their specific economic conditions.
- The Bank of Japan (Japanese central bank) had kept interest rates at zero percent between 2011 and 2016 and, in fact, pushed them even below zero (-0.10%) since 2016. The idea behind low interest rates is to stimulate economic activity.
- For instance, such low interest rates incentivise investors to borrow cheaply in yen and invest in other countries in a bid to earn better returns. Such carry trades are called yen carry trades.
