I am a huge fan of the analyses from Bank for International Settlements – BIS. A colleague shared this earlier today on the market turbulence and carry trade unwind of August 2024. The discussion on procyclical deleveraging and margin increases exacerbating volatility - as per quotes below - is something that has been discussed for more than a decade. So maybe more than continued attention? "The event was yet another example of volatility exacerbated by procyclical deleveraging and margin increases. Although an outright market dysfunction was averted this time, the structural features of the system underpinning such episodes deserve continued attention by policymakers... The reliance on leverage for many of these positions implies that investors will have to respond more strongly to adverse shocks to avoid significant losses. If such behaviour takes place in a jittery and illiquid market environment, volatility could be further exacerbated, and a negative feedback loop could be kindled". Link: https://lnkd.in/d842DxqW #bis #carrytrade #financialmarkets
Giri Pawar, CFA
2mo
David Altenhofen I believe there is a possibility more of the deleveraging to come but not to the extent we saw on Aug 5th. The dollar index DXY has dropped by 4% in the last 2 months, which puts more pressure on the yen carry trades with a depreciating dollar. And with Fed expected to cut rates by 25bps in 2 weeks, the dollar may depreciate further. This may also result in the S&P getting cheaper for non-US investors, which may result in lower implied volatilities on the VIX. Maybe there is a trade to be made in the options markets by going long puts on the VIX and long calls on the S&P 500? Interesting times for sure.
Investment and financial advisor
2moVolatility is generated by different economic cycles and different monetary policies. Japan is hiking now the interest rates, while other Central Banks are ready to cut. The “Minsky moment” coined by PIMCO in 1998, explains the view that periods of bullish speculation, if they last long enough, will eventually lead to a crisis, and the longer the period of speculation lasts, the more severe the eventual crisis will be. The longer carry trades work, the more willing investors are to steadily increase the size of their bets until there is something that breaks the game. This something has been BOJ. I think these moments of extreme fx movements are inevitable, although USDJPY at 160 was really something not sustainable. It reached that level only because BOJ was not clear on monetary policy since Q4 2023. Today we are close to where we started one year ago, December 2023, at 144.