Foreign Currency Markets – Are they the Pin for this Bubble?

Looking back to the GFC – working in finance anyone would tell you there was a problem – but it took months for people to put a finger on it, and even then, the trade was over with property markets in the US crashing and stocks dropping. The so called Yen Carry Trade in FX markets has been part of what inflated this Everything Bubble and is now getting attention as the possible pin to burst the same bubble.

Before the GFC, Michael Burry was identified as one of the convicted few who personally profited $100 million, and managed another $700 million for his investors.  How did he do this?.. He shorted the subprime US housing crash.  Subprime now seems an appropriate name for this property bubble, but at the time no one could really see behind the smoke and mirrors.  For a quick refresher, Mortgage Backed Securities (MBS) – with poor credit ratings were rolled together and turned into tranches of Collateralised Debit Obligations (CDO’s) whose risk rating suddenly (and miraculously) in hindsight turned into AAA investment vehicles. Everyone from small investors all the way to Pension funds were picking up the AAA high yielding debt which appeared to have no risk.

Other asset classes were talked about - everyone knew the financial markets were beginning to creak – stocks, futures and bonds but the one thing that was most spoken about and people always came back to was MBS and the property bubble.

The point we’re trying to make – is everyone could see the property market was in bubble territory but because of the AAA rating no one (or very few) thought it possible.  How could CDOs with multiple mortgages back with AAA ratings ever falter?  But what now everyone saw with what was in your face, they couldn’t believe these products could be sold with these ratings without someone smarter than them not knowing it was a pile of….

Which brings us to today. The market is showing bubbles both bursting and inflating – the Nasdaq continues to make all time highs with only a few stocks leading the way, the US has debt at an all-time high and increasing $1.3trillion in the last 8 weeks alone, the commercial property market is bursting, but the residential market is inflating. Lots of imbalances – but like the property bubble in the US back in the GFC, a consistent theme is of FX market breakdowns, enormous capital movements, USD de-dollarisation and proposed gold backing of currencies. People are talking most about foreign currency – so what could break this time?


So what could break?

We’ve investigated several broken foreign currency imbalances that we believe in the long term will support precious metal and cryptocurrency prices.  The USD strength (and potential de-dollarisation has created some of these imbalances - referring back to previous Ainslie articles that could refresh your memory include the new BRICS gold backed currency, RFK proposing a gold/crypto backed currency, weaponization and dedollarization.

The USD de-dollarisation & Hunt for the new trade system | Ainslie Bullion

RFK Jr. wants a Gold & Bitcoin Standard | Ainslie Bullion

BRICS to announce gold backed currency – MUST READ | Ainslie Bullion

But a notable theory has recently surfaced around the Yen Carry Trade – though not a new trade – it’s been used since the 1990s with low interest rates within Japan, but only when other global assets are so incredibly inflated by this seemingly limited shelf life trade do people start to get worried about said shelf life…

What is a Carry Trade?

It is fundamentally borrowing in one currency with a low interest rate ie the Yen and swapping it for a higher yielding asset currency such as the USD.  The higher yielding currency such as the USD is then placed into assets such as stocks, commodities or real estate and are denominated in the second currency, AKA the USD.  The return is usually greater but exposes the borrower to a risk of a sharp decline of an asset or the sharp appreciation of the first currency.

2022 Carry Trade

On the 22nd of September 2022 an article from Reuters Analysis: A quadrillion reasons the Bank of Japan should fret about Fed | Reuters identified the profitable Yen Carry Trade as the next investment boon.  With interest rates already sitting at 3% in the US and the Japanese Central Bank determined to finally see some inflation in the Japanese economy holding strong on both interest rates and yield curve control, it wasn’t hard for ‘Mrs Wantanabe, a moniker for the famed Japanese retail trader to ditch the yen and move money out.’  As the Japanese Yen has deflated 21% since 2022, the flight of capital from Japan this trade has proven another boon for the Japanese investors – trying to achieve returns greater than the BOJ 0% interest rate with a deflating currency.

But the movement of this currency has helped inflate asset bubbles around the world – as appeared last week as the Nasdaq has looked particularly bubbly in part because of this and other carry trades. So what will happen when this unwinds? Last week’s and yesterday BOJ announcements gave a reasonable hint.

Bank of Japan Signals and Finally Action

On Friday the Bank of Japan signalled a tightening of monetary policy and an adjustment of Yield Curve Control (YCC), which saw the Yen rally as much as 1.2%. However, on Monday this hawkish shift ended up disappointing markets, seeing another reversal of the Yen with the BOJ lowering its long term inflation forecast.  

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The volatility in the Yen last week and this week show the market is wary of the impact of the Yen carry trade and the BOJ will need to be careful trying to unwind it. The Friday signalling saw the SPX drop as investors fret the carry trade unwind.



If the BOJ doesn’t commit and start doing more than jawboning the Yen, the carry trade will continue and the flight of Japanese money will continue to inflate world asset bubbles.  But this will also depreciate the Yen, which is currently sitting at 25 year lows, and depreciation of a currency brings in inflation – a key goal of the BOJ – but we all know too much inflation is hard to get rid of. 

Bubbles and Carry trade reversals

The lesson I learnt being in the middle of the finance sector from the GFC – is everyone knew but it was complex and tricky so no one could understand how it was allowed to happen or how to act on it.  The same appears this time – everyone seems to know the FX and interest markets are broken, but they are so complex, asset bubbles are inflating and there is so much capital moving around the world. Its only a matter of time till something breaks – could the Yen Carry Trade be it? The market volatility these last couple of trading sessions just on jawboning ‘inferences’ by the BoJ show just how sensitive this trade is.  Stay tuned, be prepared.

We will discuss this article today in more depth on Gold & Silver Standard Insights.  Submit any questions you may have for the discussion to [email protected] and SUBSCRIBE to the YouTube Channel to be notified when the GSS Insights video is live.