To paraphrase Twain, the rumors of the U.S. dollar’s death were greatly exaggerated. Coming into 2024, the consensus opinion was that a slowing U.S. economy and Fed rate cuts should push the dollar lower. The opposite has occurred, with Asian currencies, especially the Japanese yen seeing devaluation, as its exchange rate versus the dollar fell to the lowest level since 1986.
The growth of the yen carry trade has been a byproduct of the low interest rates in Japan and a huge source of global liquidity. Carry trades try to capture the difference in yields between countries. In the yen carry trade, a market participant borrows money in Japan at a near 0% rate and then invests money into markets where rates are higher, such as the U.S.A. The trade is profitable when the yen either holds, or better yet, loses value. For the last few years, the yen has been losing value fast, making the carry trade enormously profitable (see chart and table). This popular carry trade has swelled to over $20 trillion dollars.1.
Between Covid stimulus, U.S. rate hikes, Japan’s yield curve control, China’s currency management, and tariffs, there has been large interventions into “free markets” on both sides of the Pacific Ocean. Cumulatively, these policies have strengthened the dollar and provided liquidity to the U.S. market through the carry trade. This has been one of the reasons for the dominance of U.S. stock returns over international. The differences in interest rates between the U.S. and Japan and the weakness in Asian currencies needs to normalize to prevent the introduction of larger, more dangerous imbalances into the financial system. The normalization would weaken the U.S dollar, strengthen Asian currencies, and should benefit internationally diversified portfolios.