Japan's 40-year bond yield reached 3%, a historically high level. One of the biggest concerns for investors may be yen carry trades, which have been a cornerstone of global finance and investment for the last decade.
Any sudden strengthening of the yen may trigger yen carry traders to cover their short positions quickly. Investors may then sell US Treasuries or equities to pay back the borrowed yen. Logically, these sell-offs could cause a global equity market crash or a sharp adjustment. In the 2008 crisis, unwinding yen carry trades cascaded into large equity sell-offs and a market crash.
Many traders already acknowledge the possibility, or ongoing progress, of the US dollar weakening in its dominant funding currency position in global trades and finance. As the yen strengthens, the US dollar is losing its dominant position, triggering an increase in global bond yields and interest rates, which pushes up borrowing costs.
In addition to this very direct impact, there may be spillover effects and systematic risk. Unexpected sell-offs, chaos, and tightening credit conditions could amplify the risk and create invisible fear among investors.
All the things mentioned above are real possible scenarios, and some of them have already happened. The US government and the Federal Reserve may already be aware of this. So, if the government functions normally, the anticipated risks could be controlled or adjusted to a predictable and controllable level.
Another point I have in mind is that the Japan bond yield has increased since the 2020 coronavirus crisis. This increase has been predictable and may have been discussed between US and Japanese government officials.
In conclusion, there are two combined views at this moment: a critical risk exists, and it is already acknowledged and reflected to some extent, making it acceptable.
However, this scenario is a very positive view. There are so many negative factors in the economy besides the yen carry trade. If any of those spark other issues, all those things may explode at the same time.
This article is also available on Medium by the same author
