Translate to English: The global market returns to the "US economic recession tr

This year, amidst an unpredictable monetary policy outlook from several major central banks globally, numerous countries facing elections, and ongoing geopolitical turmoil, the global market has been oscillating between "rate cut trades" and "economic recession trades." In early August, following a series of disappointing economic data, the market, concerned about the Federal Reserve's late rate cut and the risk of a "hard landing" for the U.S. economy, initiated a "U.S. economic recession trade." This was compounded by the sudden hawkish stance of the Bank of Japan, leading to a surge in the yen and the unwinding of yen carry trades, which triggered a massive shock across global markets from the U.S. to Asia-Pacific, affecting stock markets, bond markets, and currency markets.

Just over a month after the market had calmed down, history repeated itself. Last Friday, the U.S. non-farm employment data for August fell short of expectations once again, causing investors, already on edge, to swiftly return to "recession trades." The S&P 500 and the Nasdaq Composite both recorded their worst weekly performance since March 2023 and March 2022, respectively. The CBOE Volatility Index (VIX) rose to 22.38, surging approximately 49% last week. Commodities also fell across the board.

On the 9th, during the Asia-Pacific trading session, the Nikkei 225 index futures once fell by more than 5%, nearly taking over the baton of U.S. stock market volatility. The losses later narrowed, and by the time the First Financial reporter filed the article in the afternoon, major Asia-Pacific stock indices such as the Nikkei 225, the Topix, South Korea's KOSPI Composite Index, and Australia's S&P/ASX Index all saw declines of around 1%.

Analysts warn that due to the recent resurgence of yen carry trades, the impact of further unwinding of these trades on global markets should not be underestimated, as the Bank of Japan continues to raise interest rates and the yen continues to appreciate against the U.S. dollar. The turmoil in August may have been just the prelude.

Further unwinding risks of yen carry trades

Ben Emons, Chief Investment Officer and Founder of Fed Watch Advisors, stated that leveraged hedge funds have recently increased their short positions in yen futures, indicating that new carry trades have become active again. However, at the same time, the yen continued to strengthen against the U.S. dollar last week, approaching its highest level of the year, which may cause these yen carry trades to be unwound once more. He described carry trades as "Wall Street's oldest trade," not limited to yen against the U.S. dollar but also reflected in carry trades between the yen and the Canadian dollar, as well as between the U.S. dollar and emerging market currencies.

Steve Barrow, the G10 strategist at Standard Bank, wrote in a research report last Thursday: Due to the rise in Japanese interest rates and the yen, the funds that Japan has invested overseas through trade and current account surpluses over the past few decades may continue to "reverse," and the ongoing unwinding of carry trades does pose a serious threat to the optimistic outlook for risk assets.

After the Asia-Pacific market narrowly avoided another "Black Monday" on the 9th, Kathy Lien, Managing Director of Currency Strategy at asset management giant BK Asset Management, stated that as market risk aversion grows, yen traders will closely monitor global stock markets, expecting the unwinding of yen carry trades to continue, and global stock markets may face another period of aggressive selling.

Tom Nakamura, Currency Strategist and Co-Head of Fixed Income at investment firm AGF Investments, admitted that it is not common for the trend of a single country's currency to have such a broad impact on U.S. stocks. Although the 2022 UK sovereign debt crisis also affected the pound, the European bond market, and global markets, the extent was far less severe than the unwinding of yen carry trades. Regardless, he stated that the further unwinding of yen carry trades remains a significant cross-market risk, with investors concerned about the actions of the Bank of Japan over the next one to two years. Moreover, the current market volatility is still high, so the concerns about a slowdown in the U.S. economy combined with the impact of unwinding yen carry trades could be even more severe than in early August.

The Bank of Japan's monetary policy is as crucial as that of the Federal Reserve.Based on the potential impact of the Bank of Japan's (BOJ) policy on yen carry trades, Barlow stated that the monetary policy outlook of the BOJ has become as crucial as that of the Federal Reserve. Recent consecutive statements by BOJ officials, along with the general market expectation, suggest that the BOJ will continue to raise interest rates. It is worth noting that even though Japan's second-quarter real GDP growth rate, seasonally adjusted, was revised down to 2.9% on the morning of the 9th, the market's expectation for another rate hike by the BOJ within the year remained unshaken.

Takeshi Minami, Chief Economist at the Norinchukin Research Institute in Tokyo, said that the revised data is essentially within the margin of error and will not change the overall view that the Japanese economy was recovering in the last quarter. Therefore, "today's data will not really affect the BOJ's policy stance. Considering the unstable financial markets, they are unlikely to raise rates this month, but they have clearly indicated that they adhere to the idea of continuing to raise rates, so I believe there is a possibility of another rate hike this year."

Tsutomu Watanabe, a former BOJ official and a top Japanese expert on inflation research, even stated last week: "The pace at which the BOJ raises rates may be faster than the market currently expects, and there may be two more rate hikes this year." Watanabe was one of the potential candidates for the current BOJ governor. This firm expectation, coupled with the Federal Reserve's first interest rate cut in September, has led to a continuous narrowing of the US-Japan interest rate differential, and the yen continued its gains from last week against the US dollar on the afternoon of the 9th, reaching 142.99, approaching its yearly high.

Monica Defend, head of the Orient Research Institute, stated that the BOJ's surprise rate hike in July and its indication of a shift in Japanese monetary policy have completely changed the landscape for the yen. "We currently believe that the fair value of the yen against the US dollar is 140." Nakamura also sees 140 as a key level. He added that against the backdrop of the market already realizing the further unwinding risk of carry trades due to the continued appreciation of the yen, if the yen gradually appreciates further to the 130-135 range against the US dollar, the impact on the market would still be controllable. However, if this appreciation is rapidly achieved within 1-2 months, it may once again cause trouble for global investors.

Watanabe cautioned that the BOJ should strive to better communicate its monetary policy actions to ensure that the market does not panic. Barlow, on the other hand, was more pessimistic, believing that "the chaos caused by the yen's surge and the stock market's plunge in August may only be a prelude to greater market changes in the future." Arif Husain, Global Fixed Income Director and Chief Investment Officer at T Rowe Price Group, also believes that the global market turmoil on August 5 has not yet ended, and the impact of the BOJ's tightening policy and its influence on global capital flows is significant, potentially bringing significant changes in the coming years. "Although not every turmoil will lead to a major shock, market volatility may become the norm, and the global investment landscape in the next few years could be more challenging."