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As global stock markets plunged on Monday, financial analysts pointed to an esoteric trade involving the Japanese yen as a key factor for the decline. Markets have since rebounded but, with volatility surging<\/a> and investors feeling skittish<\/a>, there are fears that the unwinding of the yen-based \u201ccarry trade\u201d\u2014which describes profiting off interest rate spreads across different currencies\u2014could drive further losses.<\/p>\n The popularity of the Japanese carry trade is easy to understand. While central banks such as the Federal Reserve increased interest rates in the face of inflation, the Bank of Japan kept its interest rate near zero\u2014or even lower\u2014to incentivize economic growth. As a result, investors such as hedge funds would borrow the yen on the cheap to move into assets with higher growth potential, such as U.S. Treasuries, stocks, and other currencies. \u201cIt\u2019s one of these trades that was a no-brainer for a lot of people,\u201d said Chester Ntonifor, a foreign exchange strategist for BCA Research, in an interview with Fortune<\/em>. \u00a0<\/p>\n That all changed in late July when the Bank of Japan increased<\/a> its interest rate to 0.25% amid concern about the yen falling against the U.S. dollar. Suddenly, with the yen rising in strength, many investors were forced to exit their positions, including through potential margin calls and liquidations. \u201cIt\u2019s a classic case of up the staircase and down the elevator shaft,\u201d Scotiabank chief currency strategist Shaun Osborne told Fortune<\/em>. \u201cWhen everyone tries to get out the door at the same time, it becomes very crowded and gets ugly.\u201d<\/p>\n While the popularity of the carry trade among institutional investors is indisputable, its exact magnitude\u2014and its impact on Monday\u2019s calamitous stock market decline\u2014is still an open question.<\/p>\n Both Osborne and Ntonifor told Fortune<\/em> it would be difficult to quantify how much money had flowed into the carry trade, but Osborne pointed to a key metric that demonstrated how quickly investors were fleeing. According to his estimations, short positions in the yen\u2014meaning options contracts that borrowed the yen, betting that it would stay level or decrease in value\u2014peaked at around $31 billion in late June. New data through last Tuesday showed that the figure halved to around $15 billion, indicating that traders were closing their positions and exiting the trade.<\/p>\n The S&P 500 fell 3% on Monday\u2014its biggest<\/a> one-day drop in nearly two years. Some financial experts pointed<\/a> to the unwinding of the carry trade, with investors forced to exit their positions, which in turn would push down prices, to return yens that they had borrowed. Other factors, including a disappointing jobs report, also contributed to the decline. Still, Osborne described the carry trade as a \u201cself-feeding mechanism,\u201d where more money will continue to flow out until market sentiment improves. \u201cThe risk is certainly tilted towards more equity market weakness in the near term,\u201d he said.<\/p>\n\nMarket impact<\/strong><\/h2>\n