Hyun Song Shin on How Big the Yen Carry Trade Really Is

Episode Summary

Executive Summary: The episode demystifies the yen carry trade and argues the early-August market shock was less a simple carry-trade unwind than a broader, system-wide deleveraging episode. BIS’s Hyun Song Shin explains that FX swaps, nonbank intermediation, and global liquidity conditions make financial stress far more international and interconnected than traditional country-by-country models suggest.

Main Topics: What the carry trade actually is (Priority: 5/5): Hyun Song Shin defines the carry trade as borrowing in a low-interest-rate currency and investing in a higher-yielding one, while noting the recent public discussion oversimplified it and overstated its role in market stress. How big the yen carry trade really is (Priority: 5/5): The discussion separates on-balance-sheet yen borrowing from the larger off-balance-sheet FX swap market, emphasizing that the headline size of the yen funding ecosystem is much smaller than some market claims implied. FX swaps as the real transmission channel (Priority: 5/5): FX swaps are presented as the key mechanism allowing investors to obtain currency funding and cross-border liquidity, especially for financial institutions seeking dollar or yen exposure without direct borrowing. Why early-August stress spread beyond currencies (Priority: 5/5): The guests argue the selloff in equities and other assets cannot be explained by carry trade alone; broader risk-management rules, margin calls, and portfolio de-risking amplified the shock across markets. Global financial conditions and money fungibility (Priority: 4/5): Shin argues that financial conditions should be understood globally because swaps make money fungible across currencies, meaning tightness or ease in one market can be offset by liquidity elsewhere. Data gaps and the BIS role (Priority: 4/5): The episode highlights that official data still lag the evolution of market-based finance, and the BIS is working to gather more detailed statistics on FX swaps, counterparties, and who initiates transactions. Policy lessons and limits of intervention (Priority: 4/5): The conversation concludes that while the episode did not warrant emergency intervention, regulators should watch procyclical margins and systemic amplification, especially in nonbank markets.

Key Arguments: The carry trade is fundamentally a currency-funding strategy, not simply a speculative bet on tech stocks or Bitcoin. The public narrative overestimated the size of yen carry positions by conflating them with the entire yen-denominated banking and swap ecosystem. FX swaps are more important than balance-sheet yen lending for understanding modern cross-border funding and leverage. The early-August market drop was likely driven by broader deleveraging and risk-limit mechanisms, not just carry trade unwinds. Portfolio-level risk management can force selling across unrelated assets when aggregate losses trigger VAR or margin constraints. Financial conditions in a post-GFC market-based system are global and interconnected, because funding can be shifted across currencies via swaps. The BIS’s existing banking statistics are insufficient for today’s nonbank-dominated financial system, so more granular swap data are needed. Emergency policy intervention is generally justified only when markets become dysfunctional enough to impair real economic financing.

Data Points: Episode timing: August 23 - The hosts note they are recording the discussion on August 23, shortly after the early-August market turbulence. Carry trade unwind timing: About 2-3 weeks earlier - They refer to the unwind as having occurred roughly two to three weeks before the recording. On-balance-sheet yen borrowing: 40 trillion yen - Shin cites BIS data for yen borrowing as foreign currency, noting a sharp increase in 2022-2023. Approximate dollar value of yen borrowing: $270 billion - The 40 trillion yen figure is translated into dollar terms depending on the exchange rate. Inter-office yen lending: Around 14 trillion yen - A sizable portion of the 40 trillion yen on-balance-sheet total comes from inter-office lending within foreign banking groups. FX swap market size: Around $14 trillion - Shin says the yen-related FX swap market is much larger than the on-balance-sheet borrowing figure. VIX level: 65 - Tracy and Joe note the VIX reached 65 on the morning of August 5 during the market selloff. March 2020 comparison: Financial market dysfunction - Shin contrasts the early-August episode with the March 2020 crisis, when markets clearly broke down. Frequency of BIS banking data collection: Since 1977 - Shin explains the BIS has gathered and curated international banking data since 1977. Financial stability episode duration: 15 minutes to 1.5 days - The hosts remark that what felt like a severe crisis settled very quickly.

Pivotal Quotes: "The carry trade is a financial transaction where you borrow a currency with a low interest rate and invest in a higher interest rate." — Hyun Song Shin: A direct definition of the classic carry trade. "It’s really the whole ecosystem, if you like." — Hyun Song Shin: He explains that the actors involved in carry and swap activity span financial and non-financial institutions. "We have to think about this bigger picture." — Hyun Song Shin: He argues that the episode points to broader systemic and data challenges rather than a narrow trade unwind.

Implications: Listeners should view market shocks through a global, system-wide lens: FX swaps, nonbanks, and risk controls can transmit stress far beyond the original trade. For policymakers, better data and tighter oversight of procyclical margining are key.