The Indian market dipped by about 5% in the first week of August, leaving investors scratching their heads. This wasn't an isolated event; global markets also felt the pinch, with the Nasdaq sliding around 8% and the Dow Jones dropping nearly 7% during the same period.
While broader worries around the health of the US economy have been floating prominently, a lot of last week’s crash has also been attributed to the yen carry trade. Wait, that’s a new term, which popped out of nowhere!
What is The Yen Carry Trade
In its simplest form, the Yen Carry Trade involves borrowing money in Japan - where interest rates have historically been at rock bottom, and investing it in higher-yielding assets elsewhere.
This strategy is popular because Japan's ultra-low interest rates make borrowing cheap. Investors then convert the borrowed Yen into foreign currency, such as US dollars or Indian rupees, and invest in markets with higher returns.
When is it Profitable?
The trade is profitable under two conditions - when there's a significant yield differential between Japan and the destination country, and when the yen depreciates against the foreign currency, allowing the investor to pocket more yen when the trade is unwound.
However, these perfect conditions are now fading as global interest rates shift, making the yen carry trade less viable.
What’s Changing?
As the US Federal Reserve hints at potential rate cuts and Japan signals the opposite, the once-lucrative yen carry trade is unravelling. With Japan's central bank raising rates and the yen appreciating, the narrow yield spread is squeezing profits.
Consequently, investors are unwinding their positions, leading to outflows from markets where they had invested, including the US and Europe. This outflow is contributing to market corrections as funds are pulled out to pay back the Yen loans.
Impact on Indian Markets
So, how does this affect India? For starters, Japanese foreign portfolio investors (FPIs) have a significant presence in our stock market, holding shares worth approximately Rs. 2.06 lakh crore. Although this represents less than 3% of the total FPI exposure, the impact of unwinding yen carry trades is still felt.
As Japanese FPIs and other global investors start withdrawing their funds, Indian markets have seen a dip, though the correction has been relatively muted, thanks to domestic investors stepping in.
How Much Does it Matter?
Now, just because some high-flying trade unravels in Japan, it doesn’t mean that factories in India suddenly stop churning out products or that businesses halt their operations. The core of any stock’s value lies in the company’s earnings and ongoing business activities, not in the whims of global trading strategies.
So, while the market might be reacting to the yen carry trade unwinding, it's worth remembering that the fundamental growth story of Indian companies remains intact. This dip might just be the golden opportunity to pocket some of those watchlist stocks you’ve been eyeing.
After all, it's the long-term earnings and business growth that ultimately drive stock prices, not the temporary ripples in the global financial sea.
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