By Greg Lai and Alex Hsiao, Co-Chief Investment Officers
Tourism is booming in Japan, to the point that Japan is restricting certain locations from over-tourism. Part of the reason is the amazing fall in the yen, which has created an exchange rate for the dollar not seen in decades. Recently, one U.S. dollar could be exchanged for an incredible 160 yen, meaning a pretty good dinner in Japan might cost you US$20 or less!
But for those needing an everyday reference point, a Big Mac Meal (aka Big Mac Index) in Tokyo costs about 800 Yen. And at today’s exchange rate, that translates to about $5.00 US! In Orange County, CA, the same McDonald’s Big Mac Meal sells for a whopping US$15.11!! An arbitrage opportunity for the Big Mac Index (i.e., buy Big Macs in Japan and sell them in the U.S.)?
I can see you now searching for flights to Japan. But while you are looking for fares, know that this past week, the market experienced increased volatility that some say was caused by the unusual yen-dollar relationship.
Global markets were rocked as people pointed to the unwinding of the yen carry trade. This trade involves shorting or borrowing yen due to its very low price and investing in higher-yielding assets, like the U.S. money market or bonds and even U.S. stocks. The base case would be to borrow yen at nearly zero and invest in 5% U.S. Treasury bonds.
Yes, I did say borrow, and typically, that means margin. In recent weeks, the Bank of Japan has raised interest rates, and the U.S. dollar has weakened, reversing the yen/dollar conversion ever so slightly. In fact, current data shows that FED rate hikes have worked quite well, creating a near certainty that rate cuts are ahead.
This seems to have sent those Big Mac traders to the exits if they were not covering margin losses on their yen carry trades, which means liquidating assets, including the juicy U.S. stocks they own. This may be the best explanation for the short yet sharp technical downturn in stocks earlier in the week. After the forced short covering, stocks steadied and rebounded.
We are reminded of the dangers of “free money” and how linked our capital markets are here and abroad. Given the hot spots in the Middle East, Europe, and our own U.S. Elections, it seems easy to predict higher volatility going forward, touched off by the slightest event. But, like a good K-Drama, the reveal was short-lived, and data later in the week continued to show underlying strength in the U.S. as U.S. weekly jobless claims dropped, calming fears around the labor markets and pushing equity markets higher.
Time for a Big Mac!!… In Japan, that is!
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