Has the Carry Trade Been Fully Unwound, or is There Still More to Come?

The yen has long been regarded as a safe haven, but in August, it became the culprit behind significant turmoil in the financial markets. Early in the month, global equities and most G7 currencies plunged, while the yen surged, marking what can be described as the unwinding of the carry trade. Following the U.S. Federal Reserve’s July 31st meeting, initial optimism over potential interest rate cuts quickly soured as investors began to view the move as a sign of underlying economic weakness rather than a stimulus.¹ This shift in sentiment was aggravated by a series of disappointing economic data points, including manufacturing and jobs reports, raising concerns about the overall health of the U.S. economy. As highlighted by AMP’s chief economist Shane Oliver, this shift has reemerged with significant force, particularly in the U.S. markets. As a result, many investors were forced to close their positions, which had largely been financed by selling the yen and buying the dollar, effectively reversing much of the yen’s previous weakness.

Amidst all the chaos and excitement, the question remains on everyone’s mind: has the carry trade fully unwound? Let’s explore this.

The yen carry trade, where investors borrow yen due to the low Japanese interest rates to invest in higher-yielding assets, has long been a popular strategy. However, like most strategies, it has recently undergone a severe stress test. 

Evidence of Unfinding

According to experts from JPMorgan Chase & Co., the unwinding of the yen carry trade is far from over.² Arindam Sandilya, co-head of global FX strategy at JPMorgan, noted that the carry trade unwind within the speculative investing community is only “somewhere between 50%-60% complete.”

This rush has had significant ripple effects across both emerging and developed markets, with currencies like the Mexican peso being particularly hard-hit. The peso, which had been a major beneficiary of carry trade flows, has seen a decline of 6.8% over the past month—the most among major world currencies tracked by Bloomberg. Analysts believe that the technical damage inflicted on portfolios by the sharp move in the yen is not easily undone, suggesting that a full recovery of carry trades to previous levels is unlikely in the near term.

Adding to this perspective, Richard Kelly, head of global strategy at TD Securities, expressed caution, stating that it is still “too early” to declare the end of the carry trade unwind.³ Kelly emphasizes that the yen remains significantly undervalued, suggesting that the unwinding process may continue as the Bank of Japan potentially tightens its monetary policy further. This could lead to additional spillover effects, particularly as interest rate hikes shift in unfavorable directions for carry trades.

Recession Fears Adding Fuel to Fire

The current landscape for carry trades is further complicated by ongoing fears of a U.S. recession, which are now seen as a primary driver of the yen’s recent surge rather than the Japanese rate hikes. According to Taro Kimura, a senior Japan economist, the pace of the yen carry trade unwinding is reminiscent of the rapid reversal seen in 2007 during the onset of the subprime mortgage crisis. The future of the carry trade will likely hinge on the evolution of the U.S. economy and the Federal Reserve’s policy responses.

However, opinions are divided. Some analysts believe that most of the immediate disruption from the yen-funded carry trade unwind has already occurred. These analysts suggest that while the yen is likely to maintain its recent gains, the bulk of the turbulence might be behind us, with carry trades stabilizing in the near future.

Given these developments, it is clear that while significant progress has been made in unwinding yen carry trades, the process is not yet complete. Investors should remain cautious as further adjustments in global markets could continue to unfold.

As the yen carry trade continues to unwind, several factors will shape its future trajectory. Speculation around central bank interventions, such as a potential emergency rate cut by the Federal Reserve, raises questions about further yen strength, which could exacerbate the unwinding process rather than halt it.⁴ Similarly, while Japanese officials might attempt to curb the yen’s rise, past efforts suggest such measures would only slow its appreciation.

The stock market’s performance, particularly in the tech sector, could influence carry trades, but ongoing volatility suggests that pressure may persist. Analysts warn that the selling pressure in the yen carry trade is far from over and that volatility is expected to remain high, especially in emerging markets. Despite some signs of stabilization, opinions vary on whether the worst is behind us. While some believe that the immediate disruption may have passed, others caution that the yen could strengthen further into 2025, keeping investors on edge.

In this uncertain environment, staying vigilant and informed about central bank actions and market developments will be crucial as the carry trade story continues to evolve.

^{1 The Guardian. Share market chaos explained: what’s behind the stock meltdown and will there be a recession?
2 Yahoo! Finance. JPMorgan Says Carry Trade Unraveling Is Only Half Complete
3 CNBC. The big ‘carry trade’ unwind is far from over, strategists warn
4 Charles Schwab. Carry Trade Unwind: Is It Really Over?}