oday, Tuesday August 6, the Nikkei 225 index closed up 10.23% in Tokyo. That erased most of Monday’s 12% loss.
And it led to the U.S. futures market opening higher and U.S. stock indexes moving up today. At the close in New York, the Standard & Poor’s 500 was ahead by 1.03%, and the Dow Jones Industrial Average was higher by 0.76%. The NASDAQ Composite had gained 1.03% and the small cap Russell 2000 had added 1.23%.
The volatility eertainly isn’t over but today the market is following the usual patterns–with buying on the drop emerging after a big sell off–and that’s a big relief after the panic-inducing movement of the last three sessions. Those on Wall Street trying to figure out where we are in the unwinding of the yen/dollar carry trade that has lent so much intensity of the drop ay that the selling of dollar assets to buy ten isn’t over. Which makes sense. The financial markets have gotten so used to a weak yen that traders have assumed being short the yen was always going to be a good trade. The weak yen and low Japanese interest rates and very slow growth in Japan has meant that Japan has built up a huge foreign asset position with around $4.4 trillion of stocks and bonds held abroad. Because this trade was assumed to be good forever, many of these positions were not sufficiently hedged against the possibility of a stronger yen. That lack of hedging has meant a lot of margin calls and forced selling as well as voluntary actions to limit losses.
One good sign, if you’re looking for an end to the volatility generated by the unwinding of the yen carry trade, is that the last week has shown the re-emergence of hedges with purchases of two-year (or shorter maturity) U.S. Treasuries and a big surge in the the VIX volatility index, which tracks near-term hedging on the S&P 500.
But the sums involved in the carry trade are so huge that unwinding these positions still has a long way to go. “We are not done by any stretch,” Arindam Sandilya, co-head of global FX strategy at JPMorgan Chase told Bloomberg. “The carry trade unwind, at least within the speculative investing community, is somewhere between 50%-60% complete.”
The speed of that unwind depends to a great degree on market bets on how fast the Fed will move to cut interest rates. And on sentiment on the likelihood of a U.S.recession.
