If you’re the Fed, there are good arguments against coming out swinging with a 50bps rate cut later this month.
One of those arguments says 50bps would scare everybody to death. That’s the old “What do they know that we don’t?” worry.
Another argument says the data just doesn’t support a half-point cut currently, what with jobless claims still sub-250,000 and the unemployment rate still sitting with a low four-handle, Sahm siren aside.
I could go on. Most readers can make their own list. These are all familiar talking points.
A concern that hasn’t received as much attention in recent days relates to the read-through of 50bps for the yen, and more specifically for the yen carry trade, which garnered a disproportionate share of coverage early last month, only to fade away commensurate with the financial media’s perception of reader interest.
Note from the figure below that the yen’s coming off another barnburner week. And the spec position — a decent, if very much imperfect, proxy for the carry trade — is now the most net long in years.
The yen was 2.5% stronger last week. Some suggest the carry trade unwind’s still playing a behind-the-scenes role in episodic risk-asset turmoil.
“Something doesn’t make sense. Why are stock prices falling when the Fed is set to lower interest rates to avert a recession and to stop the unemployment rate from rising by boosting economic growth?” Ed Yardeni wondered. It was a rhetorical question which he promptly answered.
“We had a glimpse of the answer in early August: The carry trade is still unwinding,” Yardeni wrote, in the course of suggesting that rolling bouts of tumult in Magnificent 7 names and semis are a manifestation of unwinds in yen-funded longs — i.e., what you’re actually seeing when you ogle a 12% weekly drawdown for semis (for example) is a wrong-way move in traders’ funding leg.
The figure below illustrates the intuitive correlation between the US bull steepener and yen strength. The 2s10s disinverted last week, an ostensibly bad omen for the world’s largest economy.
That’s one of the more important charts in the macro-market universe.
When it comes to the yen-Nvidia nexus (the most stylized version of the trade Yardeni mentioned), I’d exercise more than a little caution in attributing each and every tick in semis and mega-cap US tech to USDJPY, but it’s obviously not a complete coincidence that, as Yardeni put it, “there has been a strong inverse correlation between the yen and the Nasdaq 100 since the start of 2023.”
As a crucial aside: You should also be wary of the chicken-egg dynamic in this discussion. Because concerns around the outlook for US growth manifest as dollar weakness (JPY strength) on the Fed read-across, it’s difficult, bordering on impossible, to disentangle bouts of US macro angst from yen carry when it comes to “explaining” risk-off price action.
The other side of this is obviously the Bank of Japan’s halting, fraught effort to dismantle the world’s most ambitious, longest-running experiment in ultra-accommodative monetary policy. In documents submitted to a government panel on September 3, Kazuo Ueda indicated that all mea culpas aside, the bank does intend to keep raising rates.
If you ask Morgan Stanley’s Mike Wilson, the Fed’s not only cognizant of all this, but in fact weighing it heavily in the decision calculus around the September 18 policy decision. “Part of our thinking is that the yen carry trade unwind may still be a risk factor behind the scenes,” Wilson wrote Monday, explaining why the bank’s house call is still for a 25bps cut this month. “A quick drop in US front-end rates could cause the yen to strengthen further, thus eliciting an adverse reaction in US risk assets tied to the carry trade unwind,” he added.
Of course, if that is indeed a factor, the Fed won’t come out and say it. And they wouldn’t have to. As Wilson went on to note, “A more measured 25bps cut at the September meeting with optionality for more significant cuts (depending on the data) seems to be more aligned with the current state of the jobs market.”
In remarks to Bloomberg TV on Monday, Yardeni reiterated the point. “You would think that the weak unemployment numbers would make the stock market go up because the Fed’s going to do 50 instead of 25,” he told Lisa Abramowicz. “That kind of [thinking] really unwound the carry trade once again, and I think that’s why the stock market was so weak last week.”
It makes sense that the carry trade should re-emerge, since rate spread remains large. But it would be a careless carry trader indeed who was caught offsides now by a 50 bp cut, and the riskiest funding destinations (NVDA, Megas, semis, MXP, etc) are near or at their 1M lows, so perhaps the incremental funding went to lower-risk destinations (bills, CP, etc) as it should.
The Fed should stick to its mandate. Inflation and employment/growth, along with the safety and soundness of the banking system, including the liquidity and functioning of the credit markets. The rest is better left to market forces, investors, and traders. The effects of the yen carry trade should only matter if it seriously impacts its core mandate. Achieving its core mandate is hard enough.
I agree. We just saw a big unwind of the yen carry trade fail to discombobbilize the functioning of the financial system. So why think that an unwind of whatever carry trade has been put back on in the last month would do it?
Some out there suggest that the Yen carry trades have been cleared out.
Now the mother lode of carry trades can be found in the yuan markets. I’d wager they are mostly done in the “bespoke” offshore yuan markets. Will the PBC be raising rates soon? Doubtful, but “administrative” efforts to shore up the renminbi are not all that unlikely.
JL – In general, the carry boys play a non-stop game of chicken with the CBs. Is a move against you a buying opportunity or reason the bail out? Often as not it’s the former, but when it’s the latter it’s painful thanks to the miracle of leverage.