Aftershocks of carry trade could still have reverberations

Investors brace for aftershocks of massive carry trade, with more unwinding ahead raising risk of market shake-outs.

Investors said the aftershocks of a massive carry trade that reverberated through global financial markets on Monday (August 5, 2024) wasn’t done yet, with more unwinding in the days ahead raising the risk of shake-outs to other assets.

The Nasdaq Composite and the S&P 500 trimmed losses by the close on Monday (August 5, 2024), capping off a brutal three-day selloff while Tokyo markets rebounded from a similar rout in trading on Tuesday (August 6, 2024).

The massive selloffs had come after a higher-than-expected U.S. unemployment rate on Friday (August 2, 2024) sparked worries the U.S. economy was heading for a recession. Concerns about the markets were exacerbated by investors winding down yen-funded trades that had been used to finance the acquisition of stocks for years after a surprise Bank of Japan rate hike last week. The so-called ‘carry trade’ is commonly used in currency markets where investors borrow money from economies with low interest rates such as Japan or Switzerland, to fund investments in higher-yielding assets elsewhere.

Despite the easing off in selling, investors were worried about more volatility ahead.

“We expect the sell-off to continue for maybe a few more days as usually these... trades are pretty large,” said Zhe Shen, head of diversifying strategies at TIFF Investment Management. “People said ‘wait, we’re losing too much money from unwinding. Let’s just hold and we’ll unwind some more tomorrow.”

The complete unwind of this yen-funded trade is likely to take days, potentially extending the market rout, Mr. Zhe said.

Investors are still scrambling to figure out the size of those trades and how much of the cheap funding was deployed in equities.