A popular trading strategy just blew up in investors’ faces

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Sometimes, markets tumble because of a big, unambiguous event, like a pandemic or a war or an economic slowdown. Sometimes, they fall because of less visible forces, like high-level financial shenanigans designed to generate profits out of thin air.

This week, markets have been grappling with both.

The selloff on Wall Street began last week with some fundamental concerns: Tech earnings were disappointing, and there were red flags in the US labor market that could indicate a serious slowdown in the world’s biggest economy.

But the financial shift that poured gasoline on the fire is more obscure, and so technical that even some longtime investors struggle to explain it succinctly.

When you hear commentators talking this week about the “yen carry trade” or the “great unwind,” they’re referring to a popular trading strategy that is, suddenly, blowing up in investors’ faces.

The carry trade, explained

Put simply: A carry trade is when you borrow money in a place where interest rates are low and use it to invest elsewherein assets that generate some kind of return.

For years, the place to get money on the cheap has been Japan, where interest rates have held steadily at or near zero.

An investor could borrow Japanese yen (for a small fee) and use that yen to buy, say, US tech stocks or government bonds or the Mexican peso — all of which have offered solid returns in recent years. In theory, as long as the yen remains low against the dollar, you can pay back what you borrowed and still walk away with a tidy profit.

“For the century so far, you would have made more money in the yen-peso