As the global economy continues to evolve, so too do the forces that shape currency markets. One such force is the yen carry trade (YCT), which has been a dominant player in shaping the Japanese yen’s (JPY) behavior over the past two decades. However, recent events suggest that the YCT may be entering a new phase, with potentially significant implications for risk management and currency markets.

To understand the YCT and its potential impact, let’s first define it. The YCT is a strategy in which investors borrow in cheap currencies (such as the yen) to invest in higher-yielding assets (such as stocks or bonds). The carry trade is fueled by the interest rate differential between the borrowed currency and the invested asset, with the goal of generating returns through the difference.

The YCT has been a powerful force in driving JPY swings over the past two decades. However, recent events suggest that this dynamic may be shifting. According to BCA, the next unwind of the YCT will likely be triggered by stress in “carry assets,” rather than narrowing rate differentials. This could have significant implications for currency markets and risk management strategies.

So what are the key factors driving this shift? One major factor is the changing nature of global trade and investment. As the world becomes increasingly interconnected, the traditional drivers of JPY swings – such as trade and export dynamics – may be less relevant than they once were. Instead, reinvestment versus repatriation of overseas income has become a more significant driver of JPY volatility.

Another factor is the growing importance of carry trades in global markets. As central banks around the world have kept interest rates low, the YCT has grown in popularity as a way for investors to generate returns in a low-yield environment. However, this has also led to increased vulnerability to market volatility and potential unwinds of the YCT.

So what does this mean for risk management strategies? Investors may need to reassess their exposure to carry trades and consider alternative ways to manage risk in a changing global landscape. This could involve diversifying assets, implementing hedging strategies, or even revising investment objectives altogether.