Part 2/6:
Before we delve deeper into the implications of the Yen's strength, it's essential to grasp the concept of carry trades. Carry trades involve borrowing in a low-interest-rate currency, like the Yen, to invest in higher-yielding assets denominated in US dollars. Japanese financial firms, often lacking lucrative domestic investment opportunities, have historically leveraged their access to the Eurodollar system to seek higher returns abroad.
However, shifts in economic conditions, particularly concerning recession risks in the US, can trigger widespread unwinding of these trades. If financial firms begin to perceive increased risk in their investments, the immediate reaction often involves liquidating positions, leading to significant financial market turbulence.