Nothing has changed. I still believe Japan remains a massive risk to global markets, and that a reversal of the yen carry trade is growing ever likely. I’ve called Japan not just some butterfly flapping its wings, but the literal Mothra from the Godzilla movies of the global financial system.
If you’ll recall, one of the arguments I made a few months back is that there is a very real risk that the Bank of Japan will be forced to intervene to save the yen. Why does the yen matter? Because Japan imports a significant amount of oil. As the yen weakens, it makes oil ever more expensive.
When we look at the Invesco CurrencyShares Japanese Yen Trust ETF (NYSEARCA:FXY) as a proxy, we can see prices are bouncing in a tight range. What happens if the floor breaks? It could be sudden and aggressive, and further add to severe inflationary pressure from a cost-push perspective.
Now this is where things get particularly dangerous. The Israel-Hamas war does risk becoming a more global conflict, and the Middle East clearly remains a major player when it comes to supplying the world with oil. So, what happens if oil prices spike in the coming weeks relative to a yen that could break its floor? It could cause shockwaves globally and result in the Bank of Japan needing to act to stabilize the currency. This means they would likely need to loosen yield curve controls or let the cap on rates float higher.
Why does this matter? Because if that happens, it could cause a global margin call.
A significant amount of leverage comes from Japan’s banking system because of rates. Any kind of sudden reversal in rates in Japan could spark a series of nasty margin calls, sending risk assets even further down a high-volatility black hole. This also would put an abrupt end to Japan’s stock market momentum. If we look at the WisdomTree Japan Hedged Equity Fund (NYSEARCA:DXJ), it’s had an incredible year. But it could be ready for a sharp reversal.
The Bottom Line
This remains a very difficult juncture for all traders and investors alike. The bond market is trading worse than cryptocurrencies, oil is subject to tail risk, and most equity investors are still fooling themselves about the safety of the AI narrative.
We are in the credit event. It started with Treasuries. It ends with junk debt. And Japan can still be the catalyst that pushes things over the edge. Investors, be warned.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.