Stock Market Chaos: Yen Carry Trade Collapse Sparks Global Panic: Peter Schiff

SchiffGold is a precious metals dealer. The company specializes in selling gold, silver, platinum, and palladium, catering to investors looking to buy physical precious metals as a hedge against economic uncertainty and inflation. SchiffGold provides a range of services, including direct purchase, secure storage solutions, and investment advice focused on precious metals. The company emphasizes the importance of owning physical metals rather than relying on paper assets, reflecting Peter Schiff’s broader economic philosophy and skepticism towards fiat currencies.

Peter Schiff is a well-known economist, financial commentator, and investment advisor. He is the CEO of Euro Pacific Capital, a brokerage firm, and the founder of SchiffGold. Schiff is recognized for his critical views on economic policies, particularly those involving central banks and fiat currencies. He frequently appears on television and radio, offering his insights on market trends, economic developments, and investment strategies. Schiff is also an author, having written several books on economics and finance.

Earlier this year, Schiff analyzed the potential unwinding of the yen carry trade following the Bank of Japan’s (BOJ) decision to terminate its long-standing zero-interest rate policy (ZIRP). According to a blog post that Schiff published on the SchiffGold website on August 3, this prediction is now materializing.

If you haven’t heard of ZIRP before, it’s a strategy used by central banks to boost the economy by setting interest rates very low or at zero. This policy makes borrowing cheaper for businesses and consumers, encouraging spending and investment to stimulate economic growth. It is typically used during economic downturns or recessions to increase demand and prevent deflation. However, maintaining ZIRP for an extended period can create financial risks, such as asset bubbles and low returns on savings.

According to a report by Reuters, on Wednesday (July 31), The BOJ raised interest rates to their highest levels in 15 years and announced a comprehensive plan to reduce its extensive bond buying, marking a significant shift away from a decade of substantial stimulus. This rate hike, the largest since 2007, defied market expectations of no change and follows the recent termination of an eight-year period of negative interest rates. At the conclusion of a two-day meeting, the BOJ’s board voted 7-2 to increase the overnight call rate target to 0.25% from the previous range of 0-0.1%, setting the short-term policy rate at its highest point since 2008.

Schiff explains that the yen carry trade involves borrowing yen at low-interest rates to invest in higher-yielding assets such as T-bills and stocks. Historically, Japan’s near-zero interest rates made yen borrowing highly attractive, Schiff notes. However, Schiff points out that with Japan now increasing its rates while other countries are lowering theirs or have already done so, the trade’s attractiveness is diminishing.

Schiff observes that investors are reacting to the loss of almost-free borrowing by selling off their yen, leading to increased volatility in the currency market. Schiff highlights that since the BoJ ended ZIRP, the yen has experienced significant fluctuations, despite multiple interventions to stabilize it.

Schiff believes that although the carry trade might persist as long as US interest rates remain higher than Japan’s, the anticipated rate cuts from the Federal Reserve this year and the BoJ’s inclination towards further hikes are escalating the risks, making the trade less appealing.

According to Schiff, Japan is an outlier in the current global trend of rate cuts, with central banks in Canada, Switzerland, Sweden, China, Mexico, Brazil, and the UK all reducing rates despite high inflation. Schiff states that recent interventions by the BoJ have strengthened the yen by 8% against the dollar after it hit its lowest exchange rate in 38 years. Higher rates in Japan are making yen-denominated investments more attractive, Schiff explains, but as the carry trade unwinds, it could give way to a “reverse carry trade.”

Schiff describes a reverse carry trade as when traders borrow yen to invest in lower-yielding currencies or assets, expecting the yen to weaken. Once the yen depreciates, they can convert these assets back into yen at a lower cost, Schiff details, profiting from both the interest rate differential and the yen’s decline.

Schiff warns that this situation has far-reaching implications for global markets. Yen volatility can disrupt leveraged positions, potentially triggering margin calls and a broader sell-off, Schiff notes. This risk is heightened if yen appreciation leads to higher commodity prices, such as oil, prompting more BoJ interventions and further unwinding of the carry trade—a scenario Schiff suggests could spiral into a global market disruption.

Schiff highlights that Japanese stocks have already shown extreme volatility, with the Nikkei 225 plummeting from a recent all-time high to levels unseen since January and the Topix index falling over 9% in two days. This dramatic drop, the largest since the 2011 Fukushima disaster, reflects domestic uncertainty amid rising interest rates in Japan and potential rate cuts by the Fed later this year, Schiff explains. These dynamics could further strengthen the yen against the dollar, leading to a complete unwinding of the carry trade, according to Schiff.

Schiff notes that the yen carry trade has historically supported bull markets globally by enabling cheap borrowing to invest elsewhere. Its unwinding could therefore induce stock market volatility beyond Japan, Schiff suggests. The BoJ faces a critical dilemma: protect the yen, stabilize the stock market, or support government bonds, of which it owns about half, Schiff observes. In a situation described by Schiff as a monetary and economic ouroboros, the BoJ has no easy solutions.

Similarly, Schiff explains that the Federal Reserve and other central banks are in a bind, trying to mitigate banking and real estate crises by lowering rates despite persistent inflation. Schiff likens the financial system to a powder keg, with the only uncertainty being who will ignite the first spark.

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