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By: Editorial Team, StoneX Media
Global markets have grown unusually interconnected, and one of the tightest links runs from a single currency trade straight into the largest technology stocks. The yen carry trade, in which investors borrow cheaply in Japan to fund higher yielding positions elsewhere, has become a hidden form of leverage sitting underneath the Nasdaq 100. Because that borrowed money helps finance richly valued technology shares, a sudden reversal in the Japanese yen can pull equities lower even when nothing has changed in the companies themselves. For anyone watching big technology stocks, the behavior of the yen has become impossible to ignore.
James Stanley is Senior Market Analyst at FOREX.com whose career spans more than two decades across equities, options, fixed income, and foreign exchange, with a focus on price action and macroeconomics. He follows currency positioning and cross-asset behavior, the markets where the yen carry trade connects foreign exchange moves to equities such as the Nasdaq 100.
The yen carry trade functions as a form of global leverage, letting large investors borrow cheaply in Japan and deploy that capital into higher yielding economies such as the U.S. "What is the carry trade but a form of global leverage", Stanley says, describing pension funds and hedge funds that fund positions in Japanese yen to chase wider interest rate spreads. Because those borrowed positions leave investors effectively short the yen, a rising Japanese currency erodes the very spread the trade was built to capture. Consequently, funds hedge that exposure by selling yen and buying dollars, euros, or pounds, which concentrates one-directional pressure in the currency. The result is a market where borrowed money, not just fundamentals, sets the tone.
A yen carry trade unwind can transmit directly into the Nasdaq 100 because the same borrowed money that funds the trade also finances positions in high flying technology stocks. When the Japanese yen strengthens and the trade turns against its holders, investors are forced to raise cash quickly, and richly valued technology names are among the easiest positions to sell. As a result, a currency move that begins in Tokyo can surface hours later as a deleveraging wave across U.S. equities. Stanley frames the danger with the image of a crowded theater, where "there's only one exit door and you start to smell smoke" and few investors will wait around to see what happens next.
The Nasdaq 100 sold off sharply during the most recent major yen carry trade unwind, showing the connection is more than theoretical. A strengthening Japanese yen forced leveraged funds to cut exposure, and the most crowded technology positions came under pressure first. According to Stanley, "you started to see major magazines and newspapers pointing to the Bank of Japan as being the reason why tech stocks started to sell off". That episode coincided with the third highest ever spike in the VIX volatility index, evidence of how quickly a currency unwind can reprice risk across equities.
A stronger Japanese yen raises the cost of the carry trades that fund many leveraged positions, forcing investors to sell assets to cover. Because high flying technology stocks are among the most richly valued and easiest to exit, they often bear the brunt of that selling. The result is a currency move showing up as pressure on the Nasdaq 100.
The gap between low Japanese interest rates and higher U.S. rates is what makes the yen carry trade profitable, so any hint that the Bank of Japan may narrow that gap can prompt investors to unwind. When those positions are cut quickly, the selling can spill into technology shares and lift measures of equity volatility. Stanley points to a past episode that coincided with one of the largest ever jumps in the VIX volatility index.
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--- Written by Gus Farrow, Senior Manager, StoneX Media
--- Expert: James Stanley, FOREX.com Senior Market Analyst
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