Yen Carry Trade Unwind Fears Re-Emerge as Risk to US Tech Rally

The prospect of further interest-rate increases by the Bank of Japan is back in focus, raising concern that an unwind of the yen carry trade could become a new risk to the rally in US technology stocks.

The Wall Street Journal reported on July 3 that the yen recently fell to its weakest level against the dollar since 1986. The currency's slide has fueled import prices in Japan, increasing the likelihood of another BOJ rate hike that could reverberate across global financial markets.

Investors are watching whether higher Japanese interest rates could trigger a reversal of the yen carry trade. The strategy involves borrowing yen at low rates and investing in higher-yielding assets such as US technology stocks. If rates in Japan rise, funds could flow back into the country and deepen selling in risk assets.

That happened last July, when the BOJ raised its policy rate to 0.25%. Japan's Topix index plunged 12% in a single day, and the Nasdaq Composite later dropped more than 13% over the following weeks. At the time, the unwind of yen carry trades was cited as a key driver of volatility in global equity markets.

The Journal said similar conditions are forming again. With US technology shares leading the market, the combination of yen weakness and the possibility of higher Japanese rates could make investors more sensitive to shifts in Japan's monetary policy.

Japan is also a major holder of US Treasuries, and the US fiscal deficit and government debt have increased sharply from past levels. Changes in Japanese capital flows could therefore have a greater impact on US financial markets.

"The market's attention is now fixed on US technology stocks, but two years ago even a small shift in the Japanese market led to a sharp drop in US tech shares and a jump in the Cboe Volatility Index, or VIX," the WSJ said. "Investors need to watch Japan's monetary policy and moves in the yen together."