How a popular trade collapsed — and why it matters

Alison: Amid the recent market volatility, I'm suddenly hearing a lot about something I honestly haven't spent much time on, the yen carry trade, which now seems to be one of the biggest focal points for investors. So what is the yen carry trade? Why did it break down? And what does it all mean for global markets? I'm Alison Nathan, and this is Goldman Sachs Exchanges.

Today, I'm speaking to Kamakshia Trivedi, the head of global foreign exchange, interest rates, and emerging market strategy research, and to Praneet Shah, who is co head of Global G 10FX Options Trading in our Global Banking and Markets division. Kamakshia, Praneet, thanks so much for being here today.

Kamakshya: Thanks for having us, Alison.

Praneet: Yes. Thank you, Alison.

Alison: Kamakshia, let's start on a very basic level. What are carry trades? How do they work or, at least, how are they supposed to work?

Kamakshya: Yeah. So at a very simple level, a carry's trade is a strategy or an investment strategy where an investor borrows in a currency where interest rates are low and invests in a currency where interest rates or what is often called in the jargon carry, the carry or interest rates are higher. And so, essentially, that strategy allows them to earn the spread between the low interest rate currency where they borrowed and the high interest rate currency where they're investing. And, typically, the kicker in these types of trades comes from the fact that in addition to the interest rate spr

Whereas in comparison to that, the US dollar or US interest rates, which went up quite meaningfully after the the pandemic surge in inflation, is you had nearly a 5 percentage point gap between interest rates in Japan or what you could borrow in the end versus what you could earn by investing in assets in bonds in the US. And if you took a even more higher yielding version of that trade, if you invested in emerging markets, another common version of this, which was borrowing in Japan or yen and then investing in Mexico, that spread was nearly 9 to 10%. So that's the kind of carry trade that we

Alison: Okay. Got it. So, Puneet, from your seat, you see actual flows into these trades. So how long have they been a feature of the market? And who's really trading these positions?

And how has it evolved recently?