What are carry trades and how did they contribute to this week's global market mayhem?
The mayhem that swept across world markets this week was partly caused by a market strategy known as the “carry trade.”
BANGKOK — The mayhem that swept across world markets this week was partly caused by a market strategy known as the “carry trade.”
Japan’s benchmark Nikkei 225 plunged 12.4% on Monday and markets in Europe and North America suffered outsized losses as traders sold stocks to help cover rising risks from investments made using cheaply financed funds borrowed mostly in Japanese yen.
Markets recovered much of their losses on Tuesday. But the damage lingers.
They were jolted by a combination of factors, including dread of a possible recession in the United States, the world's largest economy, and worries that technology shares have shot way too high this year.
But the scale of the declines was exaggerated by the rush to sell U.S. dollars due to carry trade deals that had helped drive markets to record levels.
Carry trades involve borrowing at low cost in one currency to achieve higher returns from investments in another currency. One of the most recent examples has been to borrow Japanese yen, expecting the currency to remain cheap against the U.S. dollar and for Japanese interest rates to remain low. The borrowed funds would then be invested in U.S. stocks and Treasury bonds in anticipation of a higher return.
The key factor behind a carry trade is a difference in interest rates. The Bank of Japan has kept interest rates at or near zero for years, trying to encourage more spending and spur economic growth. Last week, it raised its main interest rate from nearly zero. Higher interest rates tend to boost the value of a nation's currency, and the Japanese yen surged against the U.S. dollar. Traders
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