The Bank of Japan (BoJ) just “blinked.”

This mini-crisis was triggered by the BoJ raising rates for the first time since 2007, which in turn, blew up the Yen carry trade.

I realize that sounds as if I’m speaking in code, so let me break this down.

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As I outlined in my most recent bestseller, Into The Abyss, Japan is the grandfather of monetary insanity. The Fed first introduced Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QE) in 2008. Japan’s central bank, the Bank of Japan, or BoJ for short, introduced ZIRP in 1999 and QE in 2001, respectively.

Over the course of the last 20+ years, the BoJ has engaged in a slow-motion nationalization of Japan’s financial system. Today it owns over 50% of all Japanese Government bonds and is the single largest shareholder of Japanese stocks in the world.

All of this worked relatively well until inflation entered the financial system in 2020-2021 and the BoJ refused to address the situation.

The Fed and the European Central Bank (ECB) started raising rates and shrinking their balance sheets in early/ mid-2022. The BoJ only started tightening monetary policy in 2023. And it finally started raising rates at the end of July (as in a week ago).

That’s when all hell broke loose.

The Japanese Yen has been in a free-fall for the last four years as the BoJ refused to tighten monetary policy while every other major central bank was raising rates and draining liquidity. Indeed, going into the BoJ’s rate hike decision a week ago, the Yen was trading at levels not seen since the late 1980s.

Once the BoJ started talking about raising rates, the Yen started moving higher. And last week, when the BoJ actually raised rates, the Yen EXPLODED higher.

This is a globally systemic issue because the Yen is one of the largest carry trades in the world. If you’re unfamiliar with a carry trade, it consists of borrowing money in one currency (at a low interest rate) to invest in other assets.

Since the Yen has been yielding more or less ZERO for the last 20+ years, hedge funds and other institutional investors have been borrowing hundreds of billions of dollars’ worth of Yen to invest in other assets with EXTREME leverage.

The problem with this is that leverage works both positively and negatively.

Imagine you have $1 million to invest and you borrow $10 million in Yen at 0.1%. Your annual interest payments on the Yen are ~$10,000. Meanwhile, you invest that $10 million in stocks, which then rally 10%.

You’ve just made $1.1 million in profits (10% of your $11 million). And since your actual capital is just $1 million, you’ve more than doubled your money with this trade courtesy of leverage.

However, this process ALSO works to the downside when things go wrong. If the currency you are borrowing in (the Yen) skyrockets relative to the currency in which the assets you are buying are denominated (the $USD), your trade will BLOW up quite badly.

In the last month, the Yen/ $USD pair has ripped 12% higher. This, combined with the higher interest rate on the Yen (the BoJ raised rates from 0.1% to 2.5% last week) is BLOWING UP hundreds of billions of dollars’ worth of the Yen carry trade.

When a carry trade blows up, investors are forced to panic liquidate their holdings. That is why the market melted down over the last few weeks with companies like Apple and Nvidia collapsing in share price despite being OBSCENELY profitable.

Which brings us to today.

The BoJ announced a previously unscheduled meeting with Japan’s Ministry of Finance and its Financial Services Agency on Tuesday. This was a signal to the markets that an intervention of sorts was coming.

Soon after that, the deputy head of the BoJ, Shinichi Uchida announced that the BoJ won’t “raise rates if the markets are unstable.” This is akin to the BoJ telling the markets, “we got the message and are standing down.”

The big question now is if the lows are in… or is another round of selling coming?  Put another way, was this simply a correction in the context of a bull market… or is a legitimate crash/ bear market is about to unfold.  

One the one hand, corrections are common events in which you should “buy the dip.” But on the other hand, once every 10 years or so, a REAL crash/ bear market will hit that will wipe out years’ worth of gains!

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