Japan Dodges Rate Hike
In this issue of the peel:
Market Snapshot
Banana Bits
The Daily Poll
June’s CPI came in at 3.0% annually. Will July’s printer be higher or lower?
Previous Poll:
When do you want to buy your first home?
In the next year: 13.5% / In the next 1-5yrs: 32% / In the 6-10yrs: 30% / At least 10yrs from now: 8.5% / I already own my home: 13.5% / Never, renting forever: 5%
Macro Monkey Says
Japan Stopped A Bomb
Fine, since everyone else is talking about it, we will too.
Japan’s central bank narrowly avoided a financial disaster, preventing what could have been a self-inflicted economic crisis.
“To hike or not to hike” was the question, and, for now, we have our answer: definitely do not hike.
Let’s get into it.
What Happened?
In a couple of days leading up to last Tuesday’s open, at least a quarter trillion dollars was wiped off the face of global stock markets.
U.S. stocks led the wealth evisceration. But Japan put up some even more depressing numbers as their Nikkei 225 index (basically the S&P 500 of Japan) went full kamikaze mode and lost more than 12% on Monday alone, its worst day since 1987.
This was caused by the unwinding of the so-called “yen carry trade,” which, following the market rout, reached Taylor Swift-level popularity in financial media.
The yen carry trade is the single largest currency trade in the world.?
According to Deutsche Bank, millions from Wall Street to Japan’s main street, including pension plans, hedge funds, Japanese citizens, and the Bank of Japan (BoJ) itself, have raised the notional value of the yen carry trade to at least $20tn.
To understand what the hell is going on, we have to understand why the unwind of this incalculably large trade was triggered.
Why Happened?
As always in the markets, it wasn’t just one thing. A series of unfortunate events with particularly poor timing led to this severe financial disturbance:
All of this amounted to a fall in the bond yields, a rise in Japanese yields, and thus a spike in the value of the Japanese yen compared to the USD.
To use the technical term, this f*cked the yen carry trade’s whole sh*t up because a carry trade is essentially just a form of rate arbitrage.?
Investors borrow money at a low interest rate (like Japan’s 2-year yield of around 0.27%) and invest in assets with higher returns (like the U.S. 2-year yield of around 4%).?
The profit comes from the difference between the borrowing cost and the investment return, but this only works if currency exchange rates remain stable.
Institutions then frequently lever up this trade as it's seen as an almost automatic profit. This creates trillions of dollars in notional value attached to the same trade, with all of those leveraged dollars backed by some kind of collateral, like equities.
So, when the yen spiked against USD, this triggered a global margin call even bigger than the ones I get in my brokerage account. Investors had to dump assets to cover their positions, thus triggering the global selloff.
J.P. Morgan now estimates the unwind of the yen carry trade is 50-60% done. However, the BoJ is now in an impossible position. If inflation remains elevated, they may be forced to raise rates, potentially triggering even more unwinding.
The rest of the unwind would likely take place over a longer period, so don’t expect continued massive selloffs. But, if the BoJ continues its timing history, a repeat of last Monday is certainly plausible.
The Takeaway?
The unwind of the yen carry trade is the perfect example of when not to sell.
Above, this chart highlights the ever-present risk du jour, spooking investors and making many question their investment strategies. But, through all of these worries, U.S. equities have only continued to charge higher.
There’s always a smart-sounding reason to sell. Without risk, there’s no reward. But if history is any indicator, ignoring these perfect-for-headlines risks and events would be much kinder to your retirement account.
Luckily, I can’t read, so I can easily ignore fear-mongering headlines. But the literates among us take lessons from the ostrich burying his head in the sand.
Hope you used it as a buying opportunity—especially all you youngblood apes out there.?
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Thought Banana
Bullish Bank Branches
Atlanta is a unique place.
It’s the only city in the country where I’ve seen people playing basketball on the side of the highway. At least 71 streets have the word “Peachtree” in their names, and the Atlanta Federal Reserve is located there.
Much like the city itself, the Atlanta Fed likes to be cool, quirky, and different. Zigging while everyone else zags, this branch of the central bank just upped its GDP growth estimate for Q3.
Let’s dive in.
The Numbers
At the start of the month, the Atlanta Fed was anticipating 2.5% annualized growth via its GDPNow forecast. As of the end of last week, however, that estimate has been brought up to 2.9%.
The primary drivers of the increase include lower expected imports, higher residential investment, and, best of all, increased personal consumption expenditures.
Oh, and I almost forgot, the New York Fed had something to say too.
The bank branch from a much more forgettable city similarly increased its Q3 GDP estimate last week. The change wasn’t quite as large, going from 2.11% to 2.24%, but the increased GDP estimate is equally as notable.
Again, international trade was the primary driver, with imports now expected to come in lower while exports are expected to move higher.
The weaker U.S. dollar, driven by declining bond yields and anticipated rate cuts, could be behind the more optimistic trade outlook, but it almost doesn’t matter. What does matter is…
The Takeaway?
Increasing estimates by roughly 10 and 50bps isn’t exactly a monumental change.
But, as always, it’s the direction that matters—not the level.
Financial media is now nearly ubiquitously calling for increased recession odds or an outright recession, especially now that the Sahm “rule” has been triggered.
The divergence on display in these forecasts gives us more optimism that the U.S. economy remains in a good place, even if not as absolutely phenomenal as it has been (on paper) in recent years.
Regardless, we have about a month and a half left in Q3. Make sure you do your part to donate to the economy.?
The Big Question: Should we all be more optimistic about near-term GDP growth? How could this impact interest rate expectations?
Banana Brain Teaser
Previous
Each machine at a toy factory assembles a certain kind of toy at a constant rate of one toy every 3 minutes. If 40% of the machines at the factory are to be replaced by new machines that assemble this kind of toy at a constant rate of one toy every 2 minutes, what will be the percentage increase in the number of toys assembled in 1 hour by all the machines at the factory, working at their constant rates?
Answer: 20%
Today
The annual interest rate earned by an investment increased by 10% from last year to this year. If the annual interest rate earned by the investment this year was 11%, what was the annual interest rate last year?
Send your guesses to [email protected]
?
It's not a good idea to take a forecast from someone wearing a tie. If possible, tease people who take themselves and their knowledge too seriously.
Nassim Taleb
How Would You Rate Today's Peel?
?? Meh
?? Rotten AF
Happy Investing,
David, Vyom, Jasper, Ankit, & Patrick