Global Impact of Japan’s Rate Hike

Until recently, I bet not many understood what a ‘carry trade’ even was.

But when Japan decided to increase interest rates, all of a sudden it seemed like the whole world went into meltdown.

Despite the complex language and narrative, the basics are always simple.

In simple terms, a lot of folk — including institutions — raced to borrow money cheaply to then make good money elsewhere.

Everyone was super happy. Why? Because it was cheap.

And, if you borrow cheap, you get greedy and seek to borrow more. It’s like money for nothing. When you deploy in areas providing a higher return, you could do very well indeed.

But what happens when the folk you borrowed from cheaply decide to increase the rate of interest you borrowed?

Well, that’s what happened when the Japanese took their rate from 0.1 to 0.25.

That might hardly seem like a massive move right?

….errr, wrong!!

We need to consider the currency exchange impact. The rate going up led to more folk wanting to buy Yen, and so the value of the Yen relative to all other currencies went up.

That was the proverbial “oh shit” moment.

If you borrowed $1,000 USD worth of Yen, for example, that principal suddenly went up to $1,103. In other words, your debt could have gone up over 10% in a matter of days!

…Ouch.

Worse still, if you had used a third party to help manage the portfolio you used to buy other assets with the money you borrowed, you could suddenly find yourself in a difficult situation.

That’s because, depending on your borrowing ratio, you could suddenly be facing the prospect of liquidating assets to cover the difference. In this scenario, your assets would be sold from under you to cover the debt.

This is very likely the reason we suddenly saw a lot of sales across the various markets — including crypto — as people looked to reduce their exposure.

It would seem that no market was immune.

So now what? Will it stop? Or has the contagion just started?

The real bagman now is liquidity, as people will flee to safety and liquidity will leave at risk markets in order to cover spiraling debts.

Double ouch: no more liquidity means people flee for safety.

Still, gold and silver seem a good bet for traditional investors while BTC is the go-to for the crypto enthusiasts. Despite the initial sell off, people will look to acquire safe assets particularly as the contagion spreads.

If I look at the price of BTC today, it has started to recover some of its initial losses. Say all you like about BTC and crypto, but these markets trade 24/7 are a great barometer of what may happen in broader markets.

While the media narrative has largely moved on from this situation, I don’t believe for one minute we are out of the woods yet.

I suspect more scrambling will occur, and highly leveraged assets will be corrected.

Hell, I’d not like to be in commercial property right now.

Time will tell if this is the start of a larger correction or if it was just a deleveraging we needed to have.

On my end, I was happy to buy assets I believe in at a discount. The reality is that I’m not sure if it was a one-off sale, or the start of a much larger market rout.