What has happened in the last few days was a mad dash out of the door of all US dollar-dominated assets to buy back Japanese Yen. Why so? I have to start by explaining the Yen carry trade.

For a long time, Japan’s Central Bank has maintained an extremely low interest rate policy of between 0% and 0.1%. If you were smart money with the right access, what would you have done to earn effortless money? You would borrow Japanese Yen and convert it to US dollars. By just investing the money in US treasuries, you could immediately earn more than 5%. This is called the Yen carry trade, essentially an arbitrage of the interest rate differentials of the US and the Japanese Central banks.

In any event, the result of the Yen carry trade has been the almost endless depreciation of the Japanese Yen, the appreciation of the US dollar, and an endless supply of additional liquidity to the US stock market despite the Fed’s tight money policy. This additional liquidity pushed up all manner of asset prices. But alas, all good trade has to come to an end.

Last week, Japanese Central Bank announced that they would end the zero-interest policy.  They set the interest rate at 0.25% and gave notice of their further intention to raise the interest rate to 1%. This was a tiny change as far as policy adjustment was concerned, but that was enough to create a mad dash out the door of US assets to raise dollars, in order to buy Yen to prepay loans taken out in Yen. 

The smart money rightfully foresaw that this change in policy would cause the Yen to appreciate, reversing the two-year trend, and the earlier they can buy back Yen to repay the loan, the better for them. This is not unsimilar to someone yelling “fire!” in a crowded theater and everyone trying to get out the small exit door at the same time.

What should we do?

We are long-term investors who are not in the Yen carry trade business. There is no need for us to make a mad dash out of the door. We continue to like to own durable assets. If there is a discount on those assets, we’d like to own more.  

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