Saturday, August 29, 2015

Locus of Overnight Risk

The Yen is the largest offshore carry trade funding source in the world. Commodity and EM currency reversals are forcing carry unwind creating a momentum feedback loop via ever-stronger Yen.

The downside momentum will accelerate into the decline...

Aussie Dollar / Japanese Yen
BBG: April 19, 2015
“In a world of zero and negative yields, Aussie stands out as king ...Carry is here to stay for the foreseeable future.”

Fast forward to the foreseeable future...

Aug. 25, 2015
It's 2008 Deja Vu:

Bearing in mind that the Yuan devaluation was a mere two weeks ago...
"One of the most popular carry trades in recent months was borrowing yen to buy Australian dollars...The deals started to lose money, as weaker growth in China and falling raw-materials prices sent the Aussie tumbling toward this week’s six-year low versus the dollar." 

Overnight Yen strengthening, visualized...

Clearly a decent chunk of Japanese trillions found its way to the U.S. stock market over six years:

S&P (red) with Yen (black)

China Implosion->Aussie Implosion->Unwind Yen Carry Trade -> Yen appreciation -> Sell S&P futures overnight

The (reverse) momentum feedback loop is just getting started. 

"We're decoupled"

From reality.

"It was a bad time to be short volatility"