Carry trade investors burnt as Japanese yen loans in high-earning Mexican currency backfire.

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The yen carry trade is a financial strategy where investors borrow Japanese yen (JPY) at a low-interest rate and then use those funds to invest in higher-yielding assets denominated in other currencies. Here’s how it works:

  • Borrowing Yen: Traders borrow yen from Japanese banks at the prevailing low-interest rates.
  • Investment: They convert the borrowed yen into another currency (such as U.S. dollars or Mexican pesos) and invest in assets (such as bonds or stocks) in that country.
  • Interest Rate Differential: The goal is to take advantage of the interest rate differential between Japan (low rates) and the target country (higher rates). By doing so, they earn a profit based on the interest rate spread.
  • Profit Mechanism: The trader receives high-interest rates on the money invested (in the higher-yielding currency) but pays low-interest rates on the yen borrowed. The difference between the two interest rates contributes to their profit.
  • Currency Appreciation: Ideally, the trader benefits not only from the interest rate spread but also from currency appreciation. If the higher-yielding currency appreciates against the yen, they can sell it at a profit when converting back to yen.
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Now, let’s address the implications mentioned in your statement:

  • Burnt Fingers: The phrase suggests that someone who engaged in the carry trade using yen has suffered losses. This could happen if the value of the yen increases (making it more expensive to repay the borrowed yen) or if the value of the other currency (e.g., Mexican peso) declines significantly.
  • Liquidation: The trader you mentioned is being liquidated on a substantial Mexican peso (MXN) position. This means they are forced to sell their MXN assets to cover their yen borrowings. Such forced selling can exacerbate losses.
  • Yesterday’s Implosions: The recent stock market turmoil in Mexico may have triggered losses for the carry trader. If the Mexican peso depreciated sharply due to market instability, it would negatively impact the trader’s position.

Sources:
https://www.thebalancemoney.com/yen-carry-trade-explained-pros-cons-how-it-is-today-3305971
https://www.cnbc.com/id/100414231
https://zodiactrading.medium.com/decoding-the-yen-carry-trade-volatility-mechanism-and-risks-a3a98edf5427
https://www.federalreserve.gov/econres/ifdp/what-can-the-data-tell-us-about-carry-trades-in-japanese-yen.htm

https://www.economicshelp.org/blog/glossary/yen-carry-trade/