Last week, the stock markets’ adverse reaction to Friday’s jobs report was to price in a hard landing and toa series of federal funds rate cuts by the Fed, including a 50-basis-point cut in September. Helping to unnerve investors was that the increase in themight have triggered the Sahm Rule, implying that the jobless rate is about to soar, as it has in the past once the rule was triggered.
Show us a credit crunch, and we’ll agree that the unemployment rate is about to soar as the economy falls into a recession. The rapid unwind of carry trades injected another dose of volatility into the financial markets. Carry traders borrowing at ultralow rates in Japan effectively short the yen, borrowing and selling it to then buy other currencies of countries with higher interest rates so they can invest in those countries’ assets.
Carry trades are great until they're not. This one started to unravel in the past few weeks after Japan’s Ministry of Finance defended the currency and the BOJ subsequently started to tighten monetary policy. The risingforced carry traders to cover their shorts in the yen rapidly and to liquidate their assets that were financed by their carry trades. Many had piled into momentum stocks, including the Magnificent-7 and those in theversus more than 161.00 a few weeks ago.
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