Global Financial Markets Shaken by Yen Carry Trade Unwinding: Analyzing Key Indices and Trends

Earlier this week, a sudden surge in the yen caused the unwinding of yen carry trades, shaking global financial markets. Yen carry trade is a strategy where investors borrow yen at low interest rates to invest in markets with higher interest rates, such as the US or emerging markets. So, where did these traders invest the borrowed yen?

To investigate this, I analyzed the movements of the USD/JPY and major indices from early 2020, when the yen started to rise significantly against the dollar, to the present.

As the yen weakened (i.e., the yellow line trended upward), indices such as the Nikkei 225, NYSE FANG+, S&P 500 IT, Philadelphia Semiconductor Index, S&P 500, Nasdaq Composite, and Dow Jones moved similarly. On the other hand, the graphs of the Russell 2000, which focuses on small-cap stocks, and the S&P 500 Financials, which focuses on financial stocks, moved differently. The correlations are as follows:

Summary of Correlations with USD/JPY:

• Nikkei 225: 0.78

• NYSE FANG+: 0.63

• S&P 500 IT: 0.63

• Philadelphia Semiconductor Index: 0.55

• S&P 500: 0.50

• Nasdaq Composite: 0.48

• Dow Jones: 0.47

• S&P 500 Financials: 0.20

• Russell 2000: 0.02
  

Interpretation of the Results:

1. Nikkei 225 (0.78):

• Strongest correlation

• Indicates a very strong positive relationship between the Japanese stock market and USD/JPY

• This makes sense considering 1) a weak yen (high USD/JPY) often benefits Japanese exporters, and 2) hedge funds likely invested significantly in Japanese stocks using borrowed yen.

1. NYSE FANG+ (0.63) and S&P 500 IT (0.63):

• Strong correlation with tech-focused indices

• Indicates a significant positive relationship between large tech stocks and USD/JPY

1. Philadelphia Semiconductor Index (0.55):

• Moderate to strong correlation

1. S&P 500 (0.50), Nasdaq Composite (0.48), Dow Jones (0.47):

• Moderate correlation

• Consistent relationship between broad US market indices and USD/JPY

1. S&P 500 Financials (0.20):

• Weak positive correlation

• Indicates that the financial sector is less affected by or related to USD/JPY movements compared to tech stocks or broader indices

1. Russell 2000 (0.02):

• Negligible correlation

• Suggests that US small-cap stocks have almost no linear relationship with USD/JPY

• Indicates that small-cap stocks may be more influenced by domestic factors than currency movements
  

It is risky to draw conclusions about the relationship between the yen and indices based solely on correlation analysis. A third factor might be influencing both the yen and the indices. Therefore, I conducted one more analysis. Using the Granger Causality Test, which tests for causality between two variables, I found that while the yen influences the indices, the reverse does not hold. This means that the movements of the yen affect the indices, but the movements of the indices do not influence the yen, aligning with common sense.

Though there are limitations to relying only on correlation and Granger causality tests, these analyses provide a rough and cautious speculation on the direction of yen carry trades in US tech stocks and Japanese stocks. Please take it as an interesting read.