Written by Zhang Yaqi, Wall Street News
The unwinding of the global carry trade is turning into a rout, roiling global markets and sending the yen and yuan higher.
Major global stock indexes plunged off a cliff on Monday, with all assets including stocks and cryptocurrencies taking a beating as the sell-off in risk assets intensified.
Foreign exchange markets took a hit, with the Australian dollar falling about 2%:
Mexican peso falls more than 5% against dollar:
Two currencies often used in carry trades rose -- the yen rose more than 3%, with the dollar falling to 143 yen to the dollar;
The yuan gained about 0.7%.
The sudden appreciation of funding currencies hurt carry strategies, which involve borrowing money at a lower rate to invest in higher-yielding assets. The appreciation of the yen and yuan has made such strategies no longer profitable.
There are growing concerns that the Fed is lagging behind in its policies to support the slowing US economy. Investors are seeking bonds as safe haven assets. The US 10-year Treasury yield fell 5BP to 3.74%; China's 10-year Treasury yield fell below 2.10% for the first time on record.
The carry trade has been further hurt by higher market volatility due to fears of a U.S. recession. Alvin Tan of Royal Bank of Canada said that fears of a U.S. recession risk are an unfavorable environment for carry traders.
Recession risk also means higher volatility in the market, so carry trades are cut. I think this can easily continue because we have been in a long period of low volatility, in fact for more than a year now.
Investors who had placed their hopes on carry trades may face the fact that previously effective carry trade strategies may no longer work: the Bank of Japan raised interest rates for the second time at its recent meeting and hinted that further rate hikes may be possible; data showed that a basket of emerging market currencies denominated in RMB had a negative return, while trading gains denominated in yen were almost wiped out.
Nick Twidale, chief market analyst at ATFX Global Markets, said there was a massive sell-off of carry trade positions and "everyone was running for the exits at the same time."
