Where’d the money come from? What was the source of funds for Monday’s pre-holiday buying bonanza in Chinese equities?

Some of it probably came from mainland deposits, on which rates were falling as financial institutions struggled to preserve margins amid the PBoC’s string-pushing rate cuts. Some of it came from Chinese bonds, yields on which recently touched a succession of record lows as traders and speculators (a distinction without a difference) bet on deflation. Some of it was good ol’ fashioned margin loans.

But if you’re following along, you might’ve surmised that some of the meteoric rise in Chinese benchmarks evinced a reversal in the popular “long Japan” / “short China” trade.

From a macro perspective, China’s entering deflation and Japan’s exiting it. Investors traded accordingly in 2024. Japanese shares, you’ll recall, notched their first new record highs in three decades earlier this year before it all fell apart following the Bank of Japan’s second rate hike on July 31. In China, equity benchmarks trundled lower on their way to what, until last week, was on track to be an unprecedented fourth consecutive annual decline. Hence the consensus “long Japan” / “short China” trade.

That trade almost surely saw meaningful unwind flows on Monday. This was a perfect storm. As Chinese shares succumbed to FOMO ahead of the holiday, Japanese shares caught down to Friday’s selloff in futures. As documented briefly in the Weekly, the results of the LDP leadership contest saw Shigeru Ishiba prevail over Sanae Takaichi. Ishiba’s ok with rate hikes. Takaichi opposed them. Her loss triggered a bout of yen strength. And yen strength weighed on Japanese stocks.

As the figure shows, Monday was the worst session for the Nikkei since… well, you know. Since that day.

“The obvious FOMO grab into China before the holiday [was] painfully exacerbated [by the] unwinding of legacy China shorts and underweights… in conjunction with the ‘hawkish’ LDP leadership election [which] wreck[ed] Japanese equities and also saw rest-of-Asia with a heavy ‘source-of-funds’ trade too,” Nomura’s Charlie McElligott wrote, flagging big drops in Taiwan, South Korea and other regional benchmarks. “‘Short China’ was a funder for a lot of longs elsewhere,” he added.

The tables below give you a sense of the unwinds. They’re from Goldman’s Scott Rubner.

It doesn’t get much plainer than that: Red on one side, green on the other.

“[An] unwind of the consensus trade of ‘long Japan’ and ‘short China’ was the biggest theme” on Monday, Rubner said.

Meanwhile (i.e., as a kind of addendum) China’s quants are holding the bag on one leg of their market-neutral strategies. Suffice to say single-name longs had trouble keeping up with the index-level rally in recent days, and those strategies are generally short index. As Bloomberg noted on Monday, margin calls “continued to surge” as brokerages closed out those shorts. That, in turn, drove the indexes higher still, exacerbating the situation, delivering “the last straw on the camel,” as one fund put it.