Monday Espresso Podcast - 12th August 2024

[00:00:00] Nathan Sweeney: It is Monday the 12th of August. Today I'm joined by Andrew Shaw, our Japan analyst. Good morning, Andrew!

[00:00:06] Andrew Shaw: Good morning, Nathan.

[00:00:08] Nathan Sweeney: Now, obviously we've had an eventful week in markets with a big sell off in Japanese equities at the beginning of the week. And we're going to go through that in a lot of detail with Andrew.

[00:00:17] Nathan Sweeney: So, let's dive straight in. So, Andrew, what was happening last week?

[00:00:21] Andrew Shaw: Japan's stock market fell 12% last Monday, its worst day in 37 years, only to rebound strongly throughout the week, clawing back nearly all the losses. The initial sell off was attributed to the unwinding of the carry trade.

[00:00:35] Nathan Sweeney: Okay. So, a really big move in the market there.

[00:00:37] Nathan Sweeney: One of the worst days, as you mentioned in 37 years, you've mentioned the carry trade. So, what is the carry trade?

[00:00:44] Andrew Shaw: It's a good question. Simply put, the Yen US dollar carry trade is the act of borrowing money in Yen from a bank in Japan for virtually no cost as interest rates are so low and putting that money to work somewhere where interest rates are higher, such as the US, where interest rates are 5.5%. Interestingly, if you walk into any Japanese bank, leaflets offer products that help you do just that. Japan has had 0% interest rates for nearly three decades, which is not great for Japanese people, companies, insurance businesses, or pension funds who are all looking to earn interest on their cash. Borrowing money at 0% interest rate and investing it in, let's say the US seems like an easy way to make money. And many people have done just that.

[00:01:30] Nathan Sweeney: Okay. So that's quite interesting. So, you can see there that a lot of people starved of income in Japan, just looking elsewhere where interest rates are higher. So, it makes sense that you have that carry trade between Yen and US dollar. So, we saw the market selling off substantially that 12% sell off on Monday. So, I suppose the question is what went wrong?

[00:01:53] Andrew Shaw: One of the many risks you expose yourself to with the carry trade is currency risk. If the currency you're borrowing strengthens, in our example, Yen, then this will have a major impact on your returns. The Bank of Japan raised interest rates to 0.25% and at the same time the Federal Reserve in the United States are considering starting to cut rates.

[00:02:14] Andrew Shaw: Some weaker employment data in the US increased investors’ expectations of a quicker interest rate cut in the US. This caused the Japanese yen to strengthen rapidly against the dollar. A stronger yen makes Japanese goods more expensive and consequently less attractive to potential overseas buyers. A knock-on effect of that is that international investors have become more cautious about Japanese corporate earnings, especially those of exporters, such as car makers.

[00:02:43] Andrew Shaw: So, the market sold off.

[00:02:44] Nathan Sweeney: Okay, so, given the market sold off a lot, and then we've seen a retracing in the market. So, where you had that unemployment data you mentioned, and we did have more data this week, which actually showed things aren't that bad. People now thinking that maybe the unemployment data was impacted by poor weather because we did have a hurricane.

[00:03:04] Nathan Sweeney: So obviously clearly less people will be hiring in that environment. So, the question from here is what next? What are we expecting to happen going forward?

[00:03:12] Andrew Shaw: The carry trade will be less appealing with rising Japanese rates and falling US rates, not to mention the currency impact. The markets rebounded when they realized they overreacted, as US data is fine and US interest rate cuts will likely be more gradual.

[00:03:29] Nathan Sweeney: Fascinating there to see that kind of that circle going through in a very short period of time, big fall, big rally then as a result.

[00:03:36] Nathan Sweeney: So, thank you very much for that, Andrew. Some real insight there into the carry trade, how that works, what the impact is, and you know, what that means and how we're thinking about the world.

[00:03:45] Nathan Sweeney: So just a quick recap then on what to expect this week. So, the key data for me is we've got UK unemployment data. So, it's currently 4.4% expected to rise to 4.5. So, no meaningful change there. We've got US inflation. So, the current rate of US inflation at 3.3% and that's expected to fall to 3.2. So again, not any material movement there. And then we also have UK growth. So, GDP growth, and it is expected to be positive. So, the key takeaway there is that there's no sign of a recession. So, thank you all for listening. Hopefully you found that insightful. Thank you, Andrew, for joining me on the show today.

[00:04:22] Nathan Sweeney: And have a great week, everybody