FOMC: Fear of Missing Crash

The stage is set for the biggest end of cycle policy collision in world history, which is being conflated as an early cycle buying opportunity.

Back at the beginning of August pundits didn't see the carry trade RISK OFF coming a year ahead of time therefore they were shocked when markets were suddenly bidless overnight. The policy collision between the Fed and BOJ had been building for the entire past year, but nevertheless the normalization of BOJ policy after 30 years caught everyone by surprise. It took a global pandemic in order to finally generate enough global inflation to force the Bank of Japan to raise interest rates. At first when the pandemic ended, while other countries were busy raising rates for two years straight, Japan was the lone holdout. Which caused the Japanese Yen to collapse and it launched history's largest carry trade. The buying of assets in one currency using cheap money borrowed in another currency.

Unfortunately, Yen collapse set off inevitable rampant price inflation in Japan. Which is where pundits REALLY went wrong. They assumed the BOJ would never support the currency, and yet supporting the currency was absolutely essential in order to reduce inflation. That was the MAJOR miscalculation by carry traders. The BOJ joined the global tightening party just as it was ending everywhere else which caused the Yen to u-turn as we see in the chart below in $USDJPY terms. Which gets us to the worst case scenario of the net lender country now tightening rates on the net borrowing countries while the Yen strengthens, which leaves record hot money trapped in overseas markets.

In the meantime since August, BOJ policymakers have become MORE hawkish:

"TOKYO/AKITA, Japan, Sept 11 (Reuters) - The Bank of Japan will continue to raise interest rates if inflation moves in line with its forecast, policymaker Junko Nakagawa said, signalling that last month's market rout has not derailed the bank's plan to hike borrowing costs steadily."

And Fed policymakers have grown more dovish.

Today we got the last piece of data that cements a rate cut at next week's FOMC. Which means that anyone and everyone who is front-running rate cuts is now in the market.

Complacency is rampant.

Here we see via the Tech sector that at the August low, traders reached for put options en masse. However last week when the 50 dma was retested they reached for call options en masse. Needless to say those call option rentals have fueled a "gamma rally" off of the lows, that is now running on glue fumes and impending monthly options expiration post-FOMC.

The S&P 500 is tracing out the exact same pattern that preceded the August FOMC/BOJ meetings.

In summary, we've already seen this movie back in 2022 but that was with rate hikes and a supportive Yen carry trade. This time it will be with rate cuts and an imploding Yen carry trade. Which will put my hypothesis to the system test.