The unwinding of the yen carry trade, which some have long considered as a major risk to the global financial system, seems to be happening, if the performance of Japanese government bonds is an indication.
The yield on ten-year Japanese government bonds hit a multi-decade high of 1.88% early this month.
“These levels mark the end of the Japanese free liquidity that has been propping up the markets over the past decade,” Ipek Ozkardeskaya, a senior analyst at Swissquote, wrote in her daily newsletter.
Brij Khurana, fixed income portfolio manager at Wellington Management, observed in a blog post that Japanese investors have bought US stocks and bonds with accumulated dollars while a debt-fuelled US “overconsumed”, elevating corporate profits, mostly in the technology sector.
But now, it doesn’t pay Japanese investors to hold US assets as they can earn more from Japanese government bonds while avoiding currency risk. Khurana pointed to the US stock selloff in August 2024 as a foretaste of this.
This unwinding factors into other worrying trends, particularly a potential bubble in US tech stocks and overconcentration in US assets.
A recent chart published on Inves7.com shows that the top eight asset managers in the world by assets under management collectively manage $55 trillion, and that all but one – UBS – are US firms.
US organisations will naturally favour US assets, especially when the value is high. According to a recent report from McKinsey, global assets under management hit a record $147 trillion at the end of June, and as European investors sharply cut US exposure in the second quarter, US investors largely maintained theirs.
Such a capital concentration will naturally have a huge influence on global investment choices. But as the Thinking Ahead Institute pointed out in a recent report, the 100 largest institutional asset owners worldwide own a combined $29.3 trillion, nearly equal the total for the three largest US asset managers: BlackRock ($13.5 trillion), Vanguard ($11.6 trillion) and Fidelity ($6.8 trillion).
Those institutional assets are also far more evenly distributed worldwide. What if these assets – which the institute described as “the most influential capital on the planet” – pulled out of US stocks and US managers?
Significantly, on December 11, Oracle’s stock fell 14% as it raised spending forecasts, triggering a wider selloff on Nasdaq on concerns that the artificial intelligence boom was not boosting profitability as hoped. “AI is rewriting the cost structure of Big Tech,” Ozkardeskaya wrote.
Any revaluation of US tech stocks may be intensified if US tech employees exercise their stock options.
The options accrue tax if sold, incentivising holders to keep holding and artificially propping up valuations.
What appears to be happening now is the materialisation of a long-heralded market risk that is intensifying other correlated risks.
