How Could a Yen Carry Trade Unwind Hit Markets?

TL;DR

Rising Japanese yields and efforts to support a weakening yen could force investors and Japan itself to sell foreign assets, creating repeated global deleveraging shocks. Michael Gayed expects the danger to unfold through intermittent pulses rather than one event, potentially lifting Treasury yields first and later producing a conventional flight to safety if falling stocks intensify risk aversion.

Transcript

I think we're in a concentration bubble. Japan has been the world's bank. It's been the source of leverage for a lot of dynamics globally. I'd argue a lot of money has gone into Nvidia and the AI trade because it's been funded by the carry trade. It's not about Nvidia, it's about uh Japan. People are starting to come around to the fact that yes, Ja... Read More

Key Insights

• Japan is a major source of global liquidity because low Japanese interest rates have enabled investors to borrow yen and finance purchases of higher-yielding foreign assets. Gayed describes the country as the world's bank and a foundation for international leverage.
• A weaker yen makes dollar-denominated oil more expensive for Japan in local-currency terms. Because Japan imports all of its oil, Gayed views continued yen depreciation as a serious economic problem that could pressure authorities to intervene in currency markets.
• Currency intervention works by raising dollars and using them to purchase yen. Gayed suspects Japan may sell some US Treasury holdings to obtain those dollars, adding bond supply to the market and pushing Treasury yields higher independently of Federal Reserve policy.
• The yen carry trade can unwind when rising Japanese yields or aggressive intervention make yen borrowing less attractive. Investors may then sell foreign stocks, bonds, and other leveraged positions, potentially transmitting Japanese monetary stress throughout global financial markets.
• The market adjustment may occur in two phases, according to Gayed. Japanese Treasury sales could initially lift US yields, while sustained equity declines could later reverse that move as investors seek the relative safety traditionally associated with government bonds.
• Repeated deleveraging pulses are more likely than one isolated crisis in Gayed's framework. He expects Japanese authorities to resist yen depreciation through interventions that may provide temporary relief without overcoming longer-term free-market pressure on the currency.
• The Nasdaq and the dollar-yen exchange rate have shown a close relationship in the chart discussed during the interview. Gayed connects that relationship to Japanese savers seeking foreign risk assets, including Nvidia and the broader AI investment theme, as inflation erodes savings.
• Timing is the central uncertainty in the yen-unwind thesis. Gayed notes that the risk briefly appeared during August 3 and August 5 of the prior year, admits his timing has been wrong, and says mainstream attention may mean the event is not imminent.

Questions & Answers

Q: How does the yen carry trade fund global markets?

The yen carry trade involves borrowing yen when Japanese interest rates are low and investing the proceeds in higher-yielding foreign assets, including US and European securities. Gayed argues that this structure has made Japan a major supplier of global liquidity. He believes some of that leveraged money has entered US technology stocks, including Nvidia and the broader AI trade.

Q: Why could rising Japanese bond yields hurt foreign assets?

Rising Japanese yields can make domestic yen assets more attractive and reduce the advantage of borrowing yen to buy foreign securities. Investors may respond by selling foreign stocks and bonds, repaying yen funding, or moving capital back toward Japan. The interview argues that this reversal could produce broad selling pressure across Treasuries, equities, and other leveraged global positions.

Q: Why does a weaker yen create problems for Japan?

A weaker yen increases the local-currency price of goods purchased in dollars. Gayed emphasizes that Japan imports all of its oil and that oil is denominated in US dollars, so yen depreciation can raise Japan's energy costs even when oil behaves differently in dollar terms. He sees that pressure as a major reason authorities may try to support the currency.

Q: How could Japan support the yen through Treasury sales?

Japan could sell US Treasuries to raise dollars and then sell those dollars to buy yen. According to Gayed, this process would place additional Treasury supply into the open market and could push US yields higher. He argues that such selling might counter hopes for easier financial conditions even if the Federal Reserve is lowering its policy rates.

Q: What happens when the yen carry trade unwinds?

An unwind can force investors to sell assets purchased with borrowed yen as funding conditions become less favorable or currency intervention intensifies. Gayed expects this deleveraging to affect US stocks, Treasuries, and other global positions. The resulting losses could generate further selling, turning a Japanese currency and bond-market problem into a broader episode of worldwide risk reduction.

Q: Why does Gayed expect several deleveraging episodes?

Gayed does not expect the adjustment to occur through one clean event. He argues that Japanese authorities may intervene repeatedly to prevent further yen depreciation, but that intervention may not work permanently. Each attempt could force sales of foreign assets and create another deleveraging pulse, while longer-term market pressure may continue pushing the yen lower between interventions.

Q: Why are the yen and the Nasdaq connected in the interview?

The interview presents a chart showing a close relationship between the dollar-yen exchange rate and the Nasdaq. Gayed argues that Japanese savers facing inflation and declining purchasing power may seek returns outside Japan. He says Japanese retail investment has entered prominent US risk assets, including Nvidia and the AI theme, linking yen-funded liquidity with technology-stock demand.

Q: When could the yen carry trade become a global crisis?

The interview provides no firm date. Gayed says the risk briefly surfaced around August 3 and August 5 of the prior year, but he openly acknowledges that his timing has been wrong. He also suggests that widespread mainstream attention can reduce the likelihood of an immediate surprise. His central claim is that the risk remains present while its timing is unpredictable.

Summary & Key Takeaways

• Japan has supplied cheap funding for global risk-taking because investors could borrow low-cost yen and purchase higher-yielding foreign assets. Gayed argues that this leverage may have supported US stocks, including Nvidia and the broader AI trade, which helps explain the observed relationship between the yen and the Nasdaq.

• A weakening yen raises Japan's cost of imported, dollar-denominated oil and threatens domestic purchasing power. Japanese authorities may therefore sell US Treasuries to obtain dollars, then exchange those dollars for yen. Such sales could raise global bond yields and partially counteract any easing attempted by the Federal Reserve.

• Gayed expects repeated intervention and deleveraging episodes rather than a single decisive unwind. His proposed sequence begins with Treasury sales and rising yields, followed by a possible reversal into a traditional risk-off flight to safety if equity losses deepen. He repeatedly acknowledges that the timing remains highly uncertain.