I’ve been pounding the table for months about the risks facing the global markets from the reverse yen carry trade. The scenario I predicted is now playing out in real time and the results have been incredibly damaging to those not prepared for it.
Let’s recap a little bit. The yen carry trade worked up until roughly four weeks ago. That’s when the June inflation report was released that showed a significantly below expectations reading and pulled the calendar forward on forecasted rate cuts for the remainder of the year. U.S. interest rates fell and the yen began gaining relative to the dollar. In the background was the notion that the Bank of Japan was ready to hike rates in order to normalize conditions. The interest rate differential on the two currencies was narrowing and the yen gains against the dollar were accelerating.
Fast forward to this week. The BoJ hiked by 15 basis points, which was mildly surprising, and the Fed held interest rates steady again, but the big catalyst, of course, was Friday’s jobs report. The labor market was the one thing that many watchers pointed to as evidence that the economy is just fine and recession isn’t really a risk. But there’s clear deterioration here and when taken in context of other data we’ve received, it’s quite clear that the economy is slowing down.
The inflation rate appears to be slowing rapidly, which is what happens when there’s a lack of demand for goods and services. Initial jobless claims just hit a 12-month high. Non-farm payroll missed by a huge margin and prior month readings continue to get revised lower. The unemployment rate is at its highest level in nearly three years. The outlier in this is GDP, which continues to grow at a roughly 2% annualized pace, which wouldn’t, of course, be consistent with recession level numbers. We’ll see which one ultimately proves to be correct, but the preponderance of evidence currently favors the slowdown narrative.
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