J.P. Morgan believes 75% of the carry trade has been unwound

According to JPMorgan strategists, approximately 75% of the global carry trade has been unwound, significantly affecting year-to-date returns. They noted that the risk-reward for global carry is currently low, influenced by upcoming U.S. elections and potential repricing of funders on lower U.S. rates. The strategists also mentioned that the momentum in interest rates is expected to turn more significantly against G10 carry, prompting a shift towards value strategies. The substantial drawdowns in G10, emerging market (EM), and global carry trade baskets have erased all positive returns accumulated since the end of 2022, indicating a major impact on these investments.

The unwinding of carry trades has been particularly pronounced since the end of May, with EM currencies being the first to experience losses, followed more recently by G10 currencies. This has led to a notable reduction in returns, highlighting the vulnerability of the carry trade strategy under current market conditions. JPMorgan suggests that despite the medium to long-term deteriorating backdrop, the lighter central bank calendar next month might present a short-term opportunity to reposition for a potential repricing. They observed that value strategies have gained, FX rates momentum has recovered, and growth relative value strategies have remained resilient amidst high volatility.

Last night, the Bank of Japan (BOJ) released its Summary of Opinions, revealing a significant shift towards a more hawkish monetary policy. In a landmark decision last month, the BOJ raised its short-term policy target to 0.25%, the highest in 15 years, and discussed the possibility of further rate hikes, with one member suggesting an eventual rise to 1% or higher. This shift has caused global market turmoil, spiking the yen and leading to intense market reactions. The board's discussions highlighted concerns about rising import costs and wage increases potentially driving inflation higher than expected, indicating that additional rate hikes might be necessary.

Governor Kazuo Ueda's comments on potential future hikes, alongside the Federal Reserve's indication of possible U.S. rate cuts, further unsettled markets. Some board members expressed caution about hiking rates too soon due to weak consumption data, while others emphasized the need for gradual increases to manage inflation risks. Despite differing views, the BOJ's focus remains on adjusting monetary accommodation as needed, with discussions around the neutral rate for Japan suggesting a range between 1% and 1.5%. This ongoing debate underscores the BOJ's balancing act between curbing inflation and supporting economic growth.

Of interest, following the release of the Summary of Opinions, Bank of Japan Deputy Governor Shinichi Uchida indicated that the BOJ would refrain from further tightening monetary policy while financial markets remain unstable. This statement led to a rally in equities from Asia through Europe and into North America.

Although Uchida's comments were not an official guarantee or "verbal put" for global equities, markets reacted as if they were. It's uncertain whether the Deputy Governor can speak definitively for the entire Japanese central bank, and he may have been referring specifically to Japanese markets.