Blow-up in yen carry trade haunts markets rattled by rapid fallout

It shows how vulnerable they are to strategy used by hedge funds to bankroll mega bets

By now, the Aug 5 global market meltdown looks more like a brief tremor, a fleeting panic unleashed by a small policy shift from the Bank of Japan (BOJ) and resurgent fears of a US recession.

But the way it unfolded so rapidly and just as quickly faded out - is exposing how vulnerable markets are to a strategy that hedge funds exploited to bankroll hundreds of billions of dollars of bets in virtually every corner of the world.

The yen carry trade, as it is known, was a sure-fire recipe for easy profits: Just borrow in Japan, the world's last haven of rock-bottom interest rates, then plow it into Mexican bonds yielding over 10 per cent, Nvidia's soaring shares or even Bitcoin.

When the yen kept falling, the loans became even cheaper to repay, and the payoffs turned that much bigger.

Then, seemingly all at once, investors bailed out of the trade, in turn helping to fuel a furious rebound in the yen and a swift exodus from equities and other currencies as traders dumped assets to meet margin calls.

It roiled Japan's stock market too, setting off the fiercest one-day sell-off since 1987 on concern the surge in the currency would hammer exporters.

The pressure had been building up for weeks as markets in carrytrade hot spots sputtered, the Nasdaq-100 Index slid off record highs and worries mounted that the US Federal Reserve had kept monetary policy too tight for too long.

Then came the spark: An interest rate hike in Japan.