Equities Bounce As Carry Trade Unwinds

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group

Risk assets were sold early last week as arbitrage trades were unwound. Equities improved later in the week as risk assets rebounded.  The sell off started with the "carry trade."  From 2016 to 2024, interest rates in Japan have been in the negative range.  Investors have been able to borrow Yen at negative or near zero interest rates, convert to Dollars, then buy securities on margin.  When the Bank of Japan began to raise rates and the Fed signaled a future rate cut, this sparked margin calls on Yen "carry trades" which caused institutional investors to sell U.S. securities (and other global securities) to meet margin calls.  The volatility index (VIX) reached an intraday high of 65.7, only to settle down to 38.5 by the end of Monday.  However, it was the highest intraday swing on record for the VIX.  The worst of the selloff may be over as the Yen carry trade has been mostly unwound.

On the economic front, while the consumer remains resilient (as Redbook Sales would suggest), the economy is still expected to grow at 2.9% in the 3rd quarter, and the labor market, though normalizing, is still solid, there are some concerns beneath the surface.  Government spending, which makes up a sizeable portion of GDP, is down 6% year-over-year.  The Fed is shrinking its balance sheet and overnight lending activities, and credit spreads have widened.  The alarm bells shouldn't necessarily be going off yet, but high risk assets such as Big Tech and AI might under-perform less risky dividend-paying and under-valued equities going forward.

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