The S&P 500 fell 2.997% on Monday 5 August, the worst day for the US stock market since September 2022 and 12th daily decline >1% this year.
The graph shows the history of large down days since 1928 in the USA.
It is clear that one-day drawdowns in the equity markets are not uncommon, in fact, they create buying opportunities in most instances, depending on the reason for the fall. If something structural happens, like the mortgage-backed security market imploding in 2008, things can take a long time to recover, but it seems like this time it was something called “the Japanese Yen carry trade”.
So what is this carry trade? The carry trade happens when traders borrow in a low-yielding currency like the Japanese yen, which is relatively cheaper because the interest rate is low, and use the borrowed funds to invest in a higher-yielding asset such as bonds in countries with higher interest rates, like in the USA. The problem starts when the currency or interest rates go up in the country where you made the loan relative to the country in which you made the investment. The following example will explain: I borrow yen in Japan where the interest rate is 0.25% and convert the yen into US$ to invest in US bonds yielding 5%. But then Japan decides to increase their interest rates to 0.50%, resulting in a strengthening in the yen against the US$. This means I have a Japanese debt that is costing me more and an investment in dollars that is losing value against the currency in which I have to repay my loan. The result is a sudden unwinding of my dollar investment to repay my Japanese debt.
This trade is also called the Mrs. Watanabe phenomenon. In the early 2000s, Japanese housewives are thought to have started to supplement their meagre interest returns in their local banking system by selling the yen and purchasing USD, Euros and other currencies which paid a higher interest rate. This positive spread caught the eye of investors all over the world and soon became a popular way of making money without having to do much.
