Carry trade chaos charts outlines of next selloff
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Liam Proud
LONDON, Aug 28 (Reuters Breakingviews) -The sharpest recent market routs came from a dizzying array of sources: pandemic, war, UK pension funds, and most recently the combination of a poor U.S. jobs report and the unwinding of a popular Japanese-yen focused investment strategy. Underlying all of them, however, was a common trend of highly levered market players like hedge funds struggling to meet margin calls. There’s every reason to think it will keep happening.
Researchers at the Bank for International Settlements have repeatedly drawn attention to the worrying frequency of what they call “procyclical deleveraging”. On Tuesday, they released a first account of the Aug. 5 flash crash. The triggers, they note, were seemingly minor: a U.S. labour report on Aug. 2 that was bad but not disastrous, and the wider context of a well-flagged hawkish turn by the Bank of Japan. Somehow, that turned into a global selloff that sent the Japanese Topix Index down by more than a tenth and wiped $1 trillion off the valuation of previously popular artificial intelligence and technology stocks.
The backdrop explains the moves. For starters, hedge funds were highly leveraged: one indicator of U.S. hedge funds’ indebtedness had soared to its pre-pandemic heights. Meanwhile, investors increased their use of a strategy known as the carry trade, which involves borrowing in a currency with low rates like the yen to invest in assets denominated in high-rate ones like the Mexican peso. The BIS researchers make several stabs at trying to quantify this trade, landing on a “rough middle ballpark” estimate of $250 billion before the selloff. They think this itself is probably a lowball.
Hedge funds and other investors often execute this strategy through derivatives. When the positions lose money, or when market volatility rises, dealers and clearinghouses will typically ask the investors for higher margin levels, reducing risk. The hedge funds and other market players thus tend to need cash in the middle of a panic, forcing them to sell unrelated positions just to meet margin calls on the losing bets. That explains how a currency-linked trade and U.S. stocks became entangled. A little volatility led to margin calls, which led to broader asset sales and further volatility. In March 2020 and September 2022, a similar self-reinforcing cycle affected U.S. and UK government borrowing markets, forcing central banks to limit the price collapse by buying assets.
Regulators are alert to the recurring problem, which relates to a post-2008 effort to move risk away from banks and into markets. A triumvirate of the Basel Committee on Banking Supervision, Committee on Payments and Market Infrastructures and Board of the International Organization of Securities Commissions in January recommended various measures to make clearinghouses’ margin calls more predictable. Transparency is helpful, but it’s hard to see how it would change the fundamental dynamic. Margin calls keep blowing up markets, and there’s no end in sight.
Follow @Breakingviews on X
CONTEXT NEWS
Yen-denominated loans to financial-market players other than banks hit $250 billion in March, researchers at the Bank for International Settlements said in a bulletin published on Aug. 27. The figure is a rough proxy for the size of the popular yen carry trade, which involves borrowing in the low-yielding currency to invest in a high-yielding one.
A collapse in the trade contributed to market chaos on Aug. 5, when Japanese and worldwide stock markets slid.
The BIS researchers concluded that cascading margin calls helped to propagate the problem, as investors sold whatever they could to meet the new higher margin requirements.
Graphic: Early August market chaos quickly spread worldwide https://reut.rs/3ZlmyAP
Editing by George Hay and Oliver Taslic
Relaterade tillgångar
Senaste nytt
Ansvarsfriskrivning: XM Group-enheter tillhandahåller sin tjänst enbart för exekvering och tillgången till vår onlinehandelsplattform, som innebär att en person kan se och/eller använda tillgängligt innehåll på eller via webbplatsen, påverkar eller utökar inte detta, vilket inte heller varit avsikten. Denna tillgång och användning omfattas alltid av i) villkor, ii) riskvarningar och iii) fullständig ansvarsfriskrivning. Detta innehåll tillhandahålls därför uteslutande som allmän information. Var framför allt medveten om att innehållet på vår onlinehandelsplattform varken utgör en uppmaning eller ett erbjudande om att ingå några transaktioner på de finansiella marknaderna. Handel på alla finansiella marknader involverar en betydande risk för ditt kapital.
Allt material som publiceras på denna sida är enbart avsett för utbildnings- eller informationssyften och innehåller inte – och ska inte heller anses innehålla – rådgivning och rekommendationer om finansiella frågor, investeringsskatt eller handel, dokumentation av våra handelskurser eller ett erbjudande om, eller en uppmaning till, en transaktion i finansiella instrument eller oönskade finansiella erbjudanden som är riktade till dig.
Tredjepartsinnehåll, liksom innehåll framtaget av XM såsom synpunkter, nyheter, forskningsrön, analyser, kurser, andra uppgifter eller länkar till tredjepartssajter som återfinns på denna webbplats, tillhandahålls i befintligt skick, som allmän marknadskommentar, och utgör ingen investeringsrådgivning. I den mån som något innehåll tolkas som investeringsforskning måste det noteras och accepteras att innehållet varken har varit avsett som oberoende investeringsforskning eller har utarbetats i enlighet med de rättsliga kraven för att främja ett sådant syfte, och därför är att betrakta som marknadskommunikation enligt tillämpliga lagar och föreskrifter. Se till så att du har läst och förstått vårt meddelande om icke-oberoende investeringsforskning och riskvarning om ovannämnda information, som finns här.
