(Bloomberg) — Arif Husain says he sounded the alarm early on about rising interest rates in Japan last year, which he called the “San Andreas Fault of finance.”
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The head of fixed income at T. Rowe Price is now warning that investors have “just seen the first shift in this dislocation and that more market volatility is ahead” after the country’s July interest rate hike contributed to a sharp reversal in the yen carry trade.
The yen rose more than 1 percent against the U.S. dollar on Tuesday, hitting $145.29, ending a four-day losing streak.
While a tight monetary policy by the Bank of Japan and concerns about slowing U.S. growth contributed to strong demand for the yen on Aug. 5, investors may be ignoring a deeper cause of the global plunge in stocks, currencies and bonds, Husain wrote in a report. That includes a lot of Japanese money invested abroad that could now flow back home as interest rates continue to rise in the world’s fourth-largest economy.
“Blaming the yen carry trade ignores the beginning of a larger and deeper trend,” said Husain, whose firm manages about $1.57 trillion in assets. “The BoJ’s monetary tightening and its impact on global capital flows is anything but straightforward and will have major implications over the next few years.”
The sudden abandonment of the yen carry trade, in which the Japanese currency is sold and invested in higher-yielding assets, helped send the Nikkei index plunging to its sharpest since 1987 and fueled the VIX index of stock market volatility. Economists briefly predicted that the Federal Reserve would have to cut interest rates by half a percentage point or trade between meetings – a measure normally taken only in times of crisis.
Although the yen has settled in a trading range of 140 against the dollar, volatility remains high. Expected Fed rate cuts and further BoJ monetary tightening could shake markets again sooner rather than later.
Husain, who has nearly 30 years of investing experience, favors an overweight position in Japanese government bonds, as he believes capital will flow back into the country as yields rise. He also favors an underweight position in U.S. Treasuries – securities that he believes could come under pressure if Japanese institutions leave the U.S. and relocate to their home countries.
Husain warned of the impact of rising interest rates in Japan in June 2023, when the yen was trading at around 140 per dollar. In July this year, the currency fell to as low as 161.95 per dollar, giving carry trade investors a hefty return if they had used the currency as a source of funding and exited before the price surge in August.
“At some point, higher Japanese yields could lure the country’s huge life insurance and pension investors away from other high-quality government bonds and back into Japanese government bonds,” Husain wrote. “In effect, this would reorder demand in the global market.”
– With support from Anya Andrianova.
(Updates yen prices in third paragraph)
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