Nikkei’s Black Monday 2.0 triggers contagion talk

As the Japanese yen surges, investors are grasping for correlations — past events that provide some perspective on what might be in store for currency markets.

The search has turned frantic as the Nikkei 225 Stock Average leads a global sell-off in stocks. The Bank of Japan’s July 31 rate hike was followed by a softer-than-expected US employment report. On Monday, the Nikkei plunged 4,451 points, more than Black Monday in 1987.

Arguably, no good corollary exists thanks to uncertainties surrounding Japan thanks to the “yen-carry trade.” Though the US dollar is by far the global reserve currency, borrowing cheaply in yen and deploying those funds in higher-yielding assets elsewhere became as crowded a trade as history ever saw.

This explains why when the yen rallies, things go sideways for everything from Wall Street stocks to British gilts to Brazilian options to Indian property to Chinese corporate debt. Things tend to zig fast when the globe’s top creditor nation zags.

“The buzz is all about the contagion effect of this aggressive bear onslaught, underscored by fears of a hard landing in the US and a severe meltdown in Tokyo’s markets, which now appear to be self-perpetuating,” says Stephen Innes, managing partner of SPI Asset Management.

In a note to clients, Kinsale Trading analysts write that “the yen carry trade has been used to fund bull markets in virtually every asset over the years,” … and if it is “starting to reverse, it has negative implications for stocks and other risk assets.”

Rarely is that truer than now as Black Monday 2.0 slams Asia, sending the Chinese yuan higher, too.

Turmoil in Japan’s markets boiled over Monday as the yen extended its rebound against the dollar to about 13% from July’s low and