GLOBAL MARGIN CALL
With a high degree of confidence we can say that last week's BOJ rate hike was this era's Lehman event. The domino that catalyzed global deleveraging.
The events of this week mirror the events of October 2008 when the TARP bank bailout was hastily arranged by Hank Paulson at Treasury. When the first attempt to pass the vote in early October failed, the market crashed. The low was Monday, but then the market rallied back all week on the belief that Congress would get it passed. It was a massive short covering rally very similar to what we've seen this week on the news that the BOJ will pause rate hikes. It was guided by the belief that the "worst is over".
The week after that, the wheels came off the bus, because the damage was done.
It makes perfect sense that the Yen carry trade would be the catalyst for global margin call. Over three decades, the Bank of Japan has been the largest provider of cheap money supporting global markets, without comparison. Even while other central banks raised rates in 2022, the BOJ maintained 0%. Even as other global banks initiated Quantitative Tightening, the BOJ maintained Quantitative Easing. What resulted was a chasmic and extraordinarily profitable yield differential between Japan and the rest of the world guided by the ubiquitous belief among traders that the BOJ would NEVER reverse monetary policy.
That dumb bet exploded last week. And now, notwithstanding a massive short covering rally, the damage is done. The AI trade which was already imploding has been fatally gored.
The AI leveraged losses have already achieved 2022 post-pandemic bubble proportions.
Some things broke this week, we just don't know what. Yet.
Soon we will learn that this hedge fund or that one imploded LTCM style.
Remember LTCM? That was the massive hedge fund that had used all manner of exotic derivative trades to exploit differentials between global currencies. It was funded by cheap hot money from Japan.
"The core investment strategy of the company was then known as involving convergence trading: using quantitative models to exploit deviations from fair value in the relationships between liquid securities across nations"
This newfound belief that the carry trade is now "fixed" is totally asinine. This trade has been building for years and decades and is measured in the trillions of dollars. The idea that multiple LTCM-like hedge funds could all liquidate their portfolios in less than a week without causing global meltdown is totally false. Back in 1998 it took only ONE hedge fund unwinding to implode global markets and force the Fed to cut rates .5%. Does anyone think that every Wall Street investment bank is telling the truth about their exposure to this 100x LTCM disaster?
“You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” said Kit Juckes, a currency strategist at Société Générale.
"The size of the trade is difficult to estimate, say analysts, due to its scale and use by everyone from hedge funds, through family offices and private capital, to Japanese companies"
“The reality about the yen carry trade is that nobody exactly knows how big it is, or how much has now unwound said Benjamin Shatil, a currency strategist at JPMorgan in Tokyo"
No one knows where all the money went. But once this short covering rally ends, we will find out.
