Japan: the last carry trade.

For years private global financial institutions, particularly the hedge funds, took advantage of the so-called "carry trade." With U.S. short-term interest rates at extraordinary lows (at one point the Fed funds rate was set at 1 percent), financial institutions would borrow on the short end of the yield curve and buy the long end, guaranteeing a nice profit even before taking any risk. The carry trade served as a kind of turbo charger for the financial markets, a process which has come to an end as the Federal Reserve raised short-term rates to over 4 percent while long-term rates have failed to rise by a proportional amount comparatively, flattening the so-called yield curve.

The one exception: Japan. The discovery by global hedge funds earlier this year of the yen carry trade is likely to keep downward pressure on the yen against the dollar. The hedge funds have been taking two approaches. First, they are simply selling yen in the forward markets as a hedge against their current Japanese equity holdings. Second, they are borrowing in yen at Japan's near-zero percent rates and buying Japanese equities so that if the yen declines, their borrowing costs go even lower in dollar terms. Note that a similar development is underway in Europe, specifically with the Swiss franc. Hedge funds holding European shares are borrowing Swiss francs and investing in European equities while also selling the euro in the forward markets.