Yesterday something critical happened with the Japanese yen: It broke past the price point at which the Bank of Japan initially intervened. This means that, once again, we are at a critical juncture.
Japan represents a slow-moving currency crisis that no one is paying attention to. When they do realize what’s happening, it will be far too late. A credit event could already be happening.
Yen Panic: What’s the Deal with the Reverse Carry Trade?
Let’s revisit the entire scenario, which I initially laid out in August 2023. The idea is relatively simple.
Japan has enabled incredibly cheap leverage for decades as they country fought disinflation and outright deflation with zero or negative interest rates. The Bank of Japan maintained that stance even as nearly every central bank, the Federal Reserve in particular, embarked on their own rate-hiking cycles following the pandemic. The U.S. dollar got stronger and the yen got weaker on interest rate differentials, resulting in investors taking on a large short position on the yen.
Normally, this wouldn’t be a problem, except that Japan imports all its oil, which is still largely priced in dollars. The weaker the yen gets, the more oil priced in yen rises. And for a country that imports all its oil, that eventually means a currency panic takes place to stop or slow down the trend.
We are at that juncture again. I know a lot of people having read my warnings about a yen-triggered credit event remain skeptical because nothing has happened yet. And this is because it’s slow moving.
But none of my reasoning has changed. If the Bank of Japan panics and steps in again to save the yen, the central bank will have to take a more aggressive stance against speculators. And if it is too aggressive, it could spark a short covering rally in the yen and a subsequent volatile period for global markets.
I still think this remains the primary risk that investors face. And it may finally happen.
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.
