T. Rowe Price fixed income head warns of another yen shock

by Ruth Carson

Arif Husain says he was early in sounding the alarm on Japan’s rising interest rates last year, which he described as the “San Andreas fault of finance.”

The head of fixed-income at T. Rowe Price is now warning that investors have “just seen the first shift in that fault, and there is more” market volatility ahead after the nation’s rate hike in July helped trigger a sharp reversal of the yen carry trade. 

While a hawkish Bank of Japan and concern around slowing US growth helped trigger strong demand for the yen on Aug. 5, investors may be ignoring a deeper root of the global tumble on stocks, currencies and bonds, Husain wrote in a report. This includes loads of Japanese money invested offshore that risks getting shipped back home as rates climb ever higher in the world’s fourth-largest economy. 

“The scapegoating of the yen carry trade ignores the start of a bigger and deeper trend,” according to Husain, whose firm oversees about $1.57 trillion in assets. “BOJ monetary tightening and its impact on the flow of global capital is far from simple, and it will have a large influence over the next few years.”

The sudden abandonment of the yen carry trade, which involves selling Japan’s currency to invest in higher yielding assets, helped sink the Nikkei 225 Stock Average by the most since 1987 and fueled a surge in the VIX index of stock market volatility. Economists briefly predicted the Federal Reserve would need to cut interest rates by half a point or act between meetings — the kind of step usually reserved for a crisis.

While the yen has settled in a mid-140s trading range against the dollar, volatility remains elevated. The Fed’s anticipated rate cuts and further BOJ tightening could jolt markets again sooner rather than later. 

Husain, who has nearly three decades of investing experience, favors an overweight allocation to Japanese government bonds on the view capital is likely to flow back to the nation as yields climb. He also likes an underweight position in US Treasuries — securities he sees potentially coming under pressure as Japanese institutions move out of the US for home. 

Husain warned about the impact of rising Japan rates in June 2023, when the yen was trading around the 140 per dollar level. The currency fell to as low as 161.95 per dollar this July, handing carry trade investors a hefty return if they had used it as a source of funds and got out before the August melt-up. 

Yields on Japan’s 10-year government bonds rose 1.5 basis points to 0.92% on Tuesday, the highest since Aug. 6.  

“At some point, higher Japanese yields could attract the country’s huge life insurance and pension investors back into JGBs from other high-quality government bonds,” Husain wrote. “In effect, this would rearrange demand in the global market.”

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