No, The Reverse Yen Carry Trade Isn’t Over
Nor Is The Current Crisis Of Confidence
As I was scrolling through my news feed recently, I came across this headline:
This was written about two weeks ago, but it’s about 2-3 weeks removed from the spike in the VIX that was triggered by the unwinding of the yen carry trade.
Headlines like this and others that claim some level of certainty with regard to what comes next have always struck me as weird. In behavioral finance, this would be called overconfidence bias and self-attribution bias. You can probably already infer what these mean, but both of them have to do with an individual’s inflated belief in their own abilities and knowledge. There’s also an element of loss aversion in there, which implies that people don’t like negative outcomes so they either underestimate them or dismiss them altogether.
The reverse yen carry trade has become the poster child for this. I explained for months before it actually happened that this was a risk to the markets. Nobody wanted to think about it until they had to. Within a couple of days, everybody was suddenly an expert in it! But their expertise didn’t extend to understanding the magnitude of the risk. It was mostly centered around explaining why it wasn’t the risk the markets thought it was or explaining why it was over. After all, it’s more comfortable talking about why stocks are going to keep setting new all-time highs, not about why a crash could be coming.
That’s how we get headlines like this. That’s how we get the S&P 500 retracing all of its losses in less than three weeks. That’s why we get credit spreads stuck at historic lows despite evidence that they should be nowhere near that level. That’s why none of the big brokerages forecast losses for the S&P 500 at the beginning of every year. It’s more comfortable to think that….
In reality, nobody knows anything for sure. It’s why I always talk in probabilities or likelihoods, never certainties. It’s why I use phrases, such as “conditions favor”. Is the reverse yen carry trade over? Maybe, maybe not. One thing that I think people don’t know is how large the yen carry trade is right now. It could be a few hundred billion dollars. It could be $10 trillion. There’s so much speculation and leverage and options on options that it’s almost impossible to know. JPMorgan says that the yen carry trade is “50-60%” unwound following what happened last month. I don’t know how they arrived at that number, but I think there are a few logical arguments here as to why it isn’t over yet.
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