Echoes of a Trade: The US Dollar/Yen Carry Trade Through Time

The USD/JPY carry trade is a financial strategy where investors take advantage of the difference in interest rates between two currencies—in this case, the US dollar (USD) and the Japanese yen (JPY). Here’s how it works: Investors borrow money in a country with low-interest rates, like Japan, where the yen has historically had near-zero rates. They then convert that money into US dollars and invest it in assets or bonds that offer higher interest rates. The profit comes from the difference between the low borrowing cost in yen and the higher returns in dollars.

For example, if Japan's interest rate is 0.5% and the US rate is 5%, an investor can earn a 4.5% profit on the difference, assuming the exchange rates stay stable. This strategy has been particularly popular during periods when Japan kept its interest rates low for extended times, making borrowing cheap.

However, the carry trade isn’t without risks. If the value of the yen increases against the dollar, the cost to repay the borrowed yen becomes more expensive, which can wipe out profits or even lead to losses. Additionally, global economic shifts can suddenly change interest rates or currency values, adding to the unpredictability.

The USD/JPY carry trade has played a significant role in global finance, influencing currency markets, and contributing to economic bubbles. While it can offer substantial rewards, it’s crucial for investors to understand the potential risks and to monitor the markets closely to avoid unexpected losses.

I wanted to put something quickly together for investors to receive a historical summary of what could be ahead of us, assuming the USDJPY has run its course and will revert to much lower prices.

Here are some interesting mileposts for the USDJPY trade.

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?CYCLE TOP???????????????????????? CYCLE BOTTOM

?June 14,1989?????????????????????? April 17, 1995

?January 23,2002????????????????? April 15, 2011

?June 26, 2024??????????????????????? ??????????

Here is a Point and Figure chart highlighting the trade since 1986. There have been two extended up moves and two (soon to be three) extended down moves in the USDJPY carry trade. ?The blue lines represent what happened historically. The gold line is my interpretation of how it could look if history is our guide.?

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Let’s explore the rate of return for assets and indexes to educate ourselves on what could be possible if the market were to behave like it did last time.?

From January 23, 2002, through August 15, 2011 here is a list of the Rolling Cumulative returns for the following indexes and commodities.

Here we can see that Commodities clearly outperformed stocks and equity indexes. Gold + 471%, Copper + 467%, Crude Oil + 349%, Consumer Price Index + 125%.

The S&P 500 offered virtually no return, being + 6.67% over the 9 years. I suppose this is where the phrase “The Lost Decade” came from! Clearly US markets suffered tremendously by 2 back-to-back bubbles bursting.

Lets’ review the period of the S&P 500 from June 14, 1989, to Aril 17, 1995. Here it paints quite a different picture. This may be one of the greatest bull market runs to ever hit Wall Street. Investors did remarkably well with their stock portfolios.

Here the S&P 500 rallied approximately 70% from 296 to 504 over that time period.

High Grade Copper

Basically, unchanged over the time period from 1989 to 1995.

Gold Continuous

Here gold rallied from around $375/ ounce to $398 an ounce. Not too impressive.

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US Consumer Price Index (CPI) YoY

This might have been the sweet spot for consumers is that after an initial spike in prices, the US saw a massive decline in prices for consumers from 1990 to 1995. ?

NIKKEI-225 Clearly the Japanese market gets absolutely crushed with the Nikkei 225 declining from 38,800 to 15,600 a decline of 60%.

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Conclusion

The US Dollar / Japanese carry trade remains a powerful yet complex strategy that has shaped global financial markets for decades. Its allure lies in the potential for significant profits, particularly during periods of sustained interest rate differentials.

However, as history has shown, the carry trade is not without its risks, with economic shifts and currency volatility posing serious challenges. Investors must approach this strategy with caution, armed with a deep understanding of market cycles and a vigilant eye on global economic indicators. While the rewards can be substantial, the path is fraught with potential pitfalls, demanding both skill and foresight.

The S&P 500 could be poised for an attractive upside rally; or carve our sideways action in what may be another Lost Decade. Either way, keeping a close watch on stocks, bonds, commodities and option premiums may provide the investor with many opportunities to grow wealth in an uncertain future.

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?** Warning Investors need to educate themselves on the myriad number of Exchange Traded Products (ETP) that permit an allocation to a basket of commodities. Be aware that these products are complex derivative products that do not actually own the physical commodity or a futures contract and will also with high probability create a K-1 Partnership Tax Form, which complicates your tax returns. Investors MUST read and understand the prospectus of these commodity-based ETFs.

Commodities are regulated by the Commodity Futures Exchange (CTFC) while Exchange Traded Products are generally regulated by the Securities Exchange Commission (SEC). There can be VERY complex instruments inside an ETP which you might buy in an IRA or 401K.

Cenacle Capital Management, LLC Glenview, IL www.cenaclecapital.com Phone: 847-686-4800

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