The Yen Carry Trade Wasn't What Crashed Markets: BIS Expert Reveals the Real Numbers

Hyun Song Shin from the Bank for International Settlements debunks widespread misconceptions about the yen carry trade's role in August 2024's market volatility, revealing the actual scale and mechanics behind global currency flows.

The Bank for International Settlements' top researcher explains why the yen carry trade panic was overblown, how FX swaps dwarf traditional lending, and what really triggered August's brief but intense market chaos.

Key Takeaways

• The actual yen carry trade is much smaller than portrayed, with only $270 billion in cross-border yen lending versus $4 trillion in FX swaps
• August 2024's market stress lasted just days but wasn't primarily driven by carry trade unwinding, contrary to popular narrative
• FX swaps create global money fungibility, making local financial conditions less relevant than worldwide liquidity flows
• Risk management amplification effects, not fundamental economic news, likely caused the sharp but brief market volatility
• The shift from bank-based to market-based financial systems requires new data collection and monitoring approaches
• Non-bank financial intermediaries now dominate currency markets, making traditional banking statistics inadequate for systemic risk assessment
• Emergency rate cuts weren't justified since markets showed no signs of complete dysfunction or broken financing flows
• Global financial conditions indices are needed to understand modern cross-currency funding and investment patterns

Timeline Overview

• 00:00–12:30 — Defining the Carry Trade: Basic mechanics of borrowing low-yield currencies to invest in higher-yield assets, distinguishing classical currency trades from broader interpretations
• 12:30–25:45 — Market Participants and Scale: Who actually engages in carry trades, BIS data showing $270 billion in yen lending versus popular misconceptions about total size
• 25:45–38:20 — FX Swaps Dominate: The $4 trillion FX swap market dwarfs traditional lending, creating off-balance-sheet currency exposure and global money fungibility
• 38:20–52:10 — August 2024 Crisis Analysis: Why the brief market chaos wasn't primarily carry trade driven, role of risk management amplification in spreading volatility
• 52:10–65:30 — Global Financial Conditions: How currency swaps make money fungible globally, explaining disconnect between high US rates and accommodative credit conditions
• 65:30–78:45 — Policy Implications: Need for better non-bank data, margin procyclicality issues, and why emergency rate cuts weren't warranted
• 78:45–End — Future Monitoring: Challenges of tracking speculation and bubbles in evolving market-based financial system

Debunking the Carry Trade Hysteria: What Actually Happened

The August 2024 market volatility sparked widespread panic about massive yen carry trade unwinding threatening global financial stability. Hyun Song Shin, the Bank for International Settlements' economic adviser and head of research, provides crucial perspective on what actually occurred versus the dramatic narratives circulating in financial media.

• The classical carry trade involves "borrowing a currency with a low interest rate and then investor proceeds in other higher yielding assets," typically currency-to-currency transactions
• Popular discourse vastly expanded this definition to include "going into all kinds of different assets" like technology stocks, creating misleading impressions about scale
• BIS data reveals only $270 billion in cross-border yen lending as foreign currency, far below the "trillions" suggested by market commentary
• The sharp market moves affected equity markets "very broadly across the world in a way that you wouldn't have expected if it were a sort of narrow carry trade story"
• Classical carry trades did unwind, evidenced by currencies that "fell most in early August" being "the Mexican peso Colombian Peso and the Rand"
• However, this narrow unwinding cannot explain "much more broad-based stress especially in the equity markets" that characterized the period

The disconnect between the limited scale of actual carry trades and the global market impact suggests other mechanisms were at work. Understanding these dynamics requires moving beyond simplistic narratives about currency speculation to examine broader risk management and funding structures.

The Real Players: Who Actually Engages in Carry Trades

Contrary to popular perceptions of massive hedge fund speculation, carry trade participants span "the whole ecosystem" with actors shifting based on market conditions and structural needs. The motivations range from legitimate hedging to opportunistic arbitrage across different institutional types.

• Non-financial institutions represent "the textbook case" with exporters and importers hedging currency exposure from international trade transactions
• Financial institutions increasingly dominate since the global financial crisis, making "financial uses of the FX swap Market which has really grown much larger"
• Insurance companies exemplify structural users: "a Euro area insurance company" wanting "a globally Diversified portfolio including dollar assets" while maintaining euro-denominated obligations
• Cross-border banking creates significant flows through "inter Office Accounts" where foreign banking groups lend from Japanese subsidiaries to headquarters
• The inter-office component alone accounts for "around 14 trillion" yen of the total 40 trillion yen in cross-border lending flows
• Hedge funds and proprietary trading desks engage in classical carry trades but represent a smaller portion than commonly assumed

"Since the global financial crisis it's the financial uses of the FX swaps which are the lion's share of the FX swap market." This institutional shift reflects broader changes in how global finance operates, with market-based intermediation replacing traditional bank lending as the dominant funding mechanism.

Size Matters: Separating Facts from Fiction About Scale

The most significant misconception about the yen carry trade involves dramatically overstating its actual size, with some commentary suggesting the entire Japanese banking system represented carry trade exposure. BIS data provides concrete numbers that deflate these exaggerated claims.

• Total cross-border yen lending as foreign currency reaches approximately 40 trillion yen, equivalent to roughly $270 billion depending on exchange rates
• This figure includes all yen lending outside Japan, "not all of that is going to be engaged in Yen carry trade"
• Inter-office lending between foreign bank subsidiaries and headquarters accounts for 14 trillion yen of the total
• On-balance sheet lending represents only a fraction of total currency market activity compared to derivative instruments
• Popular market estimates conflating Japan's entire banking system with carry trade positions were "orders of magnitude" too large
• The $270 billion actual scale, while significant, pales compared to daily global foreign exchange turnover exceeding $7 trillion

These numbers matter because policy responses and risk assessments based on inflated estimates could lead to inappropriate interventions. "We are going to do that right now and I am so pleased to say that we do in fact have the perfect guest" to clarify these crucial distinctions between perception and reality.

FX Swaps: The $4 Trillion Shadow Market That Really Matters

While media attention focused on traditional carry trades, the far larger FX swap market creates the real funding infrastructure enabling global currency arbitrage. This off-balance-sheet activity dwarfs conventional lending and creates systemic interconnections largely invisible to standard monitoring.

• The FX swap market between yen and other currencies reaches "around $4 trillion," vastly exceeding the $270 billion in on-balance sheet lending
• FX swaps involve delivering one currency "with the promise that that transaction would be reversed at a set date in the future at an agreed exchange rate"
• Traditional hedging uses swaps to offset currency mismatches, but speculative use involves "just sell that Yen on the spot market and acquire dollars"
• This creates "a naked Yen obligation which I will need to meet at the time by repurchasing the Yen on the spot market"
• The swap basis typically shows dollar funding is more expensive than yen funding, but "during this recent episode" the "dollar FX basis versus the Yen hardly budged"
• Minimal basis movement during the August stress was "very atypical of a financial stress event," suggesting the crisis wasn't primarily about dollar funding shortages

The FX swap market's dominance reflects the evolution toward market-based finance where "you can basically overcome that particular constraint" of being limited to your funding currency through derivative instruments rather than balance sheet expansion.

August 2024 Anatomy: Risk Management Gone Wrong

The brief but intense market chaos of early August 2024 demonstrated how modern risk management systems can amplify rather than mitigate stress, creating feedback loops that spread volatility far beyond its original source. Understanding these dynamics reveals systemic vulnerabilities in contemporary financial architecture.

• Fundamental economic news was "not that big a surprise" with "some surprises at the margin but nothing major" to justify the market response
• Value-at-risk rules trigger automatic position cutting when "risk is triggered Beyond this V level then I cut my position" regardless of underlying rationale
• Margin requirements increase during stress periods, forcing "deleveraging" exactly when markets need liquidity most
• Multi-strategy firms create hidden correlations where "one pod doesn't know what the other pod is doing" but aggregate risk limits affect all positions
• The result mimics the old saying "in a crisis you sell what you can not necessarily" what's causing the problem
• Portfolio-wide risk constraints mean "if the aggregate portfolio is suffering losses then the risk limits are tightened for all the different assets"

This mechanism explains why equity markets globally experienced stress despite the narrow currency focus of actual carry trade unwinding. The lesson: "we're putting too much weight on the carry trade as a key theme of what happened in early August."

Global Money: How Currency Swaps Reshape Financial Conditions

The proliferation of FX swaps fundamentally alters how monetary policy transmission works by making money "fungible across currencies," creating global rather than national financial conditions. This evolution helps explain puzzling disconnects in recent years between interest rate levels and credit availability.

• FX swaps "make money fungible across currencies" so "$5 I can get you know Yen vice versa" enabling global arbitrage
• Traditional financial conditions indices measure domestic interest rates and credit spreads but miss cross-currency funding dynamics
• Goldman Sachs index and similar measures show "rates have been raised to quite high levels" yet "stock markets credit spreads have been extremely accommodated"
• The explanation: "if we have a world where essentially money is fungible across currencies" then "it's really about what the global picture is"
• Capital flows to "the most competitive section of the money market and the swap is the instrument that's going to really give you that fungibility"
• Global money supply aggregates have shown "quite rapid" growth despite tight domestic policies in major economies

This global perspective suggests central banks operating in isolation may find their policies less effective than historical relationships would predict. "Money will flow to the most competitive section of the money market" regardless of domestic regulatory or monetary constraints.

Policy Lessons: Building Better Financial Surveillance

The August episode exposed significant gaps in official sector monitoring of market-based finance, highlighting the need for updated data collection and regulatory frameworks suited to contemporary financial system architecture. These improvements require international coordination and new analytical approaches.

• Traditional banking statistics cover "only a very small part of the overall universe" as finance has moved toward market-based intermediation
• "Non-bank financial intermediaries are taking on a much bigger role" requiring new monitoring approaches beyond conventional bank supervision
• Margin procyclicality remains problematic: "margins don't get eroded too thinly during good times so that they're raised very sharply" during stress
• Emergency rate cuts weren't justified because markets showed no "complete dysfunction" where "nothing is being sold or bought"
• Better FX swap data needs "who is the instigator," "where is it being booked," and "what are the sectors that the two parties are coming from"
• The challenge is continuous: "you can never declare Victory because the financial system is always evolving"

"Given the shift away from the very Bank Centric system to something which is much more a market-based system which we have now I think this is really something that we need to do as a matter of urgency." The official sector must adapt its tools to match financial system evolution.

Common Questions

Q: How big is the yen carry trade really?
A: About $270 billion in cross-border yen lending, much smaller than the $4 trillion FX swap market that enables broader currency arbitrage.

Q: Why did global equity markets crash if carry trades are relatively small?
A: Risk management amplification effects spread stress across unrelated positions when portfolio-wide limits were triggered during volatility.

Q: Should central banks have cut rates during the August crisis?
A: No emergency cuts were needed since markets continued functioning without complete breakdown in financing flows to the real economy.

Q: How do FX swaps affect monetary policy transmission?
A: They make money fungible across currencies, creating global rather than national financial conditions that can bypass domestic monetary tightening.

Q: What data gaps need addressing for future crises?
A: Better tracking of non-bank financial intermediation, FX swap counterparties, and global rather than national financial condition measures.

The August 2024 yen carry trade panic demonstrated how quickly misconceptions can spread in modern markets, amplified by incomplete data and outdated analytical frameworks. Hyun Song Shin's analysis reveals the actual mechanisms at work were far more complex than simple currency speculation, involving risk management systems and global funding structures that require new approaches to monitoring and policy response. The episode's rapid resolution without lasting damage suggests financial markets retain more resilience than panic narratives suggested, but also highlights the need for better real-time understanding of evolving market dynamics.

Practical Implications

• Distinguish carry trade scale from FX swap volumes — Focus monitoring on the $4 trillion derivative market rather than $270 billion in traditional lending
• Monitor risk management procyclicality — Address margin increases and position limits that amplify rather than dampen market stress
• Develop global financial condition indices — National measures miss cross-currency funding that makes money fungible worldwide
• Improve non-bank financial data collection — Traditional banking statistics miss the majority of modern financial intermediation
• Resist emergency policy responses to brief volatility — Wait for signs of complete market dysfunction before extraordinary intervention
• Track amplification mechanisms across asset classes — Multi-strategy firms create hidden correlations through shared risk limits
• Update regulatory frameworks for market-based finance — Bank-centric rules miss the dominant non-bank intermediation channels
• Enhance international data coordination — Cross-border flows require multilateral monitoring approaches beyond national statistics