Reverse Carry Risks Are Back!

00:00:00: Japan's bond yields are rising to levels that were simply unthinkable just a few years ago.

00:00:06: The latter fuels the risk of another episode of reverse carry trade, one.

00:00:17: The longer the Middle East tensions drag on, the stronger inflationary pressures become pushing global yields even higher and increasing pressure on already stretched equity valuations.

00:00:28: So welcome to Swisscoats.

00:00:29: daily market talk is Tuesday, May, I'm Ipek Oskar Deshkoia And we will talk about their reverse carry trade risks and opportunities for investors.

00:00:40: but before you do as always Please keep in mind that opinions are my own and this is not financial advice.

00:00:55: So the week started on a mixed note... In Europe, the retreat in European bond yields yesterday gave a certain relief to equity indices allowing the stock six hundred indexes keep floor bowed.

00:01:06: The fifty-day moving average while major US indices have failed to maintain an earlier optimism and U.S session that was fueled by news at Washington reportedly proposed a temporary wayward Iran on sanctions then us denied report shortly after and optimism just evaporated.

00:01:25: This morning we're back to square one.

00:01:27: There is no material progress in the Iranian peace talks, global yields are rising and equities or under pressure again The Japanese ten year yield which has now become the first thing that I look at In the morning when i turn on my computer it's pushing toward a two point eighty percent mark Again level.

00:01:45: That was unthinkable just few years ago.

00:01:47: Rising oil prices fuel inflation and bioj rate hike expectations Justifying their rise in the japanese while Ekamik data released this morning.

00:01:57: in Japan also bats a further sell-off in the JGB's because Japanese economy grew more than two percent and Better than expected.

00:02:07: Consumption also rose more than expected by analysts, while price pressures in the first quarter did not ease as penciled-in by analysts and the latter boosted the hawkish Bank of Japan expectations.

00:02:20: The expectation that the bank of japan would raise interest rates to tame inflationary pressures In Japan a scenario that echoes through US yields Because Japan is one of the largest foreign holders off US Treasuries.

00:02:33: For years, Japanese investors such as their big pension funds and insurers bought U.S government bonds simply because yields in Japan were extremely low often close to zero making U. S bonds far more attractive in comparison And that liquidity entered the US treasuries also went beyond them into global risk assets Such as equity indices for example.

00:02:58: But that could change today if Japanese government bond yields rise.

00:03:04: rise.

00:03:05: A year ago, for example we were saying that if the ten-year JGB yield climbed toward a one seventy five to one seventy seven percent range.

00:03:13: domestic bonds would start becoming attractive again from major Japanese institutions because they can earn a decent return at home without taking the currency risk, hedging costs or overseas exposure.

00:03:25: That becomes withholding US Treasuries and foreign assets.

00:03:29: And that matters Because if large Japanese investors starts shifting even part of their money back into the Japanese domestic bonds.

00:03:36: All demand for US treasuries could weaken, potentially putting more pressure on U.S.

00:03:41: yield and downward pressure on related risk assets.

00:03:45: And it's exactly what we see this morning.

00:03:47: We see that the US ten-year yield is pushing past a four point sixty percent level which is the highest level in A year.

00:03:54: And that doesn't necessarily please the US indices, they are in a negative this morning at the time I'm talking here.

00:04:00: On other news China which is another big U.S.

00:04:03: Treasury holder joined global set off of U. S. Treasuries in March according to latest news.

00:04:08: as Iran war prompts panic and beyond the Iran War.

00:04:11: China has been reducing risk holding U. s treasuries since years now.

00:04:16: replacing their U.s treasury holdings The USD reserves by gold and letter echoed by other central banks is expected to maintain goals positive trend in check.

00:04:27: in the medium to long run.

00:04:28: So I'm going to make a small stop there before i continue with the reverse carry trade, In short one.

00:04:34: gold remains under pressure of rising yields because higher sovereign yields increase opportunity cost of holding non-interest bearing gold making yellow metal more affordable for long term investors and I generally believe that every tick lower how we see in gold prices is an opportunity to strengthen longterm bullish positions become the new asset that big institutions and especially central banks are moving toward.

00:05:02: But anyway, coming back to the rising Japanese yields... The latter is becoming a growing risk for global risk markets because again as Japanese repatriate their money back home ...the US Treasury yields push higher and higher.

00:05:14: U.S.

00:05:14: yields echo across global yields and higher yields weigh on equity valuations.

00:05:20: That mechanism is called the reverse carry trade.

00:05:23: It's simply the Japanese pulling the rug from under of the global markets.

00:05:27: And last time, the latter happened in August, two thousand and twenty-four following a Bank Of Japan rate hike to Nikkei had lost twenty percent in a few days as Nasak exposed to chip yen.

00:05:38: funding has dived around fourteen per cent.

00:05:41: today with stretch valuations scenario like this becomes increasingly possible especially if the bank of japan moves ahead was an interest rate high and is increasingly expected to raise its interest rate from point seventy-five percent to one percent at that meeting.

00:06:02: So how do you recognize a reverse carry trade?

00:06:05: Well, the biggest tell is a violent drop in dollar yen combined with a small ten years' drop in equities and collapsing yields confirming a risk of the leveraging event.

00:06:14: And this far because Japanese yields remain notably low below that important one seventy five to one seventy seven per cent threshold for the ten year JGB yield.

00:06:24: While reverse carry trade episodes mostly resulted in a temporary panic only, a temporary boost of the leveraging and short lived stress across global markets.

00:06:35: Investors eventually returned to borrowing the cheap yen and chasing higher returns abroad because they yield advantage.

00:06:41: still overwhelmingly favored foreign assets But those were moving sustainably above that one seventy-five, one seventy seven percent threshold for the ten year yield.

00:06:50: And as Japan is making its way out of a two decade long deflation which was THE reason why Japanese yields were so low in first place well the risk is we could see something far more structural happen.

00:07:03: The next reverse carry episode could actually trigger a gradual and sustainable reallocation of Japanese capital back home as domestic bonds in Japan start offering sufficiently attractive returns to investors without the currency risk.

00:07:17: And hedging costs are tied too overseas investments, that would simply mean a durably less funding for global markets from the Japanese because Japan is one of the world's largest pools of savings.

00:07:32: A sustained repatriation flow could reduce demand for US tertiary and global risk assets, put upward pressure on global borrowing costs.

00:07:40: And strengthen the yen structurally from actual levels and tighten global liquidity conditions after years of abundant and cheap Japanese funded capital supporting everything literally everything from us technology sucks to emerging market stocks.

00:07:57: but that's a theory because in practice if you ask me how worried I am about losing Japanese liquidity?

00:08:02: Well, I would say that i'm not extremely worried about lower Japanese liquidity.

00:08:06: I am sure the Fed and other central banks could easily fill in their liquidity gap by quantitative easing R&P or any programs to inject money into the financial system.

00:08:18: And that's exactly why the durable and notable rise we've been seeing in the ten-year JGB yield above the one seventy five, one seventy seven percent threshold did not lead to a massive sell off.

00:08:30: That many expected in global financial markets and many warned very loudly about.

00:08:37: on the contrary Global liquidity just kept rising on this steep upward trajectory.

00:08:43: A large part of that liquidity eventually found its way into global equity indices and other risk assets across the globe.

00:08:51: That's why it only makes sense today to buy them, And stay invested in equities when stock price inflation is inevitable due to sustained liquidity injection globally.

00:09:03: That's the name of the game.

00:09:05: Stay invested.

00:09:06: and one last thing about their money injection, that new Fed chair Mr Kevin Walsh is willing to reduce the size off the feds incredibly high balance sheet and balanced negative impact by lowering interest rates.

00:09:17: but I don't believe once second back he could do that.

00:09:20: i Don't believe that He Is going To be able to lower the interest rate And even less reduced the size Of The Feds balance sheet.

00:09:27: So voila, the game continues.

00:09:29: The global liquidity remains ample and the latter remain strongly supportive of equity valuations.

00:09:35: And investors are finding all the reasons in the world to close their eyes on geopolitical risks arising, especially in the medium-to long run.

00:09:43: This is exactly what we see in very small dip buying episodes because dips are barely noticeable today!

00:09:50: Now, it doesn't mean that the risks are not there.

00:09:53: But I think that a ten to twenty percent retreat in global equities would only mean opportunity for investors who are looking to increase their positions and their exposure too.

00:10:03: global risk assets.

00:10:04: Voila, that's the thinking!

00:10:06: So this is all for This Tuesday.

00:10:08: I'm Yipega Skardishkaya and thank you for joining me And Thank You For All Your Beautiful And Supportive Comments.

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00:10:47: I will meet again tomorrow and until then, good day

00:10:53: trading!

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