World stock, drop and roll
When last week ended the stock markets had taken a tumble to close the week out on a weak July jobs report and several other excuses depending on how aggressively you wanted to frame the pitch of a potential recession.
This week continued the tumble with stocks dropping hard from the opening bell. On Aug. 5, the Nasdaq, Dow and S&P all finished more than 2.5% lower on the day. A large move lower especially considering that it was coming off a similar two-day slide the previous week.
Why now? As mentioned, last week’s sell off was seen as a combo of recessionary concerns backed up by two to three months of weaker jobs report data and perhaps a building crescendo of concern about what this year’s election results will bring, as campaigns pushed into uncharted waters. These narratives certainly provided the bears with fuel for a fire but seemed to lack the spark as they were mostly known before the slide.
The spark appears to have come from the now infamous “yen-carry trade.” Simply put, the yen-carry trade is a long-standing foreign exchange strategy that seeks to take advantage of cheap interest rates and a cheap currency in the Japanese Yen. In the most simplistic terms, traders are short the yen while being potentially long anything else in an offsetting manner.
As Japan has been engaged in a multi-decade-long battle against an economy suffering from sagging inflation to outright deflation, it’s been a popular trade for foreign investors.
Last week the Bank of Japan announced it would be raising the target interest rate on government bonds and sharply reducing the amount of bonds it buys as part of its efforts to control interest rates. The move looks to take the Japanese 10-year government bond rate from its current level of 0 or .1% to a .25% target. Small in comparison to the U.S. government 10-year bond rate currently hovering around 4%, but more than double where the rate currently stands.
It’s not just the yen value or the Bank of Japan interest rates on their own, either. It’s the narrowing of the gap between them and everything else, whether it be a stock market retreating from the highs, U.S. interest rates looking to pull back with a more dovish Fed or the raw price of commodities drawing down from recent highs.
On Monday traders rushed for the exits on the yen-carry trade and found the exits were crowded. The rest of the week was a back-and-forth battle that kept equity markets above Monday’s low and well below last week’s highs (as of Friday morning). Time will tell whether the yen-carry trade is blimp on the radar simply marking a change in trading procedures or the catalyst for a deeper recessionary pullback.
Information contained herein is believed to be reliable but cannot be guaranteed as to its accuracy or completeness. Past performance is no guarantee of future results or profitability. Futures and options trading involve substantial risk of loss and is not suitable for all investors. All information, including this specific material, used and distributed by Pinion Futures LLC (PF) shall be construed as a solicitation for entering into a derivatives transaction. PF does not distribute research reports, employ research analysts, or maintain a research department as defined in CFTC Regulation 1.71.