Worry about the US economic outlook causing global stock markets to crash?

On Monday (August 5), analysts said the rout in global stock markets in recent days reflected more a reduction in carry trades used by investors to increase their positions than a sharp shift in the outlook for the U.S. economy.

They added that while Friday's weaker-than-expected US jobs data served as a catalyst for the stock market sell-off, Japan's blue-chip Nikkei suffered its biggest one-day drop since the Black Monday sell-off in 1987 on Monday, and the jobs report alone was not enough to be a major factor in triggering such wild swings.

Instead, the answer may lie in further significant positioning squaring of carry trades, with investors borrowing from low-interest-rate economies such as Japan or Switzerland to fund investments in higher-yielding assets elsewhere.

They were caught off guard as the yen has risen more than 11 per cent against the dollar from a 38-year low hit a month ago.

foreign exchange trading platform"We think a lot of this [market sell-off] is due to position capitulation, as many macro funds made mistakes in their trades and triggered stop-losses, starting with FX and the yen," said Mark Dowding, chief investment officer, referring to predetermined levels that triggered buying or selling.

He added: "We don't see any data that suggest the economy is facing a hard landing."

(Dollar/Japanese Yen one-hour chart)

One Asian investor, who asked not to be named, said some of the largest systemic hedge funds traded stocks based on algorithmic signals but began selling when the Bank of Japan's surprise interest rate hike last week sparked expectations of further tightening.

While exact numbers and the specific changes in positioning behind the moves are hard to come by, analysts suspect that the crowded positions in US tech stocks, funded by carry trades, are responsible for the worst impact on these stocks.

As of press time, the US Nasdaq stock index, which accounts for a high proportion of technology stocks, has fallen more than 8% so far in August, while the Standard & Poor index has fallen 6%.

Driven by years of ultra-loose monetary policy in Japan, the carry trade has triggered a cross-border yen lending boom to fund deals elsewhere, ING said.

The BIS noted that the bank's data shows that cross-border yen borrowing has increased by $742 billion since the end of 2021.

"It's yen-funded arbitrage position squaring and Japanese equity position squaring," said Tim Graf, head of European macro strategy at State Street Global Markets. "Our position metrics show that investors are overweight Japanese stocks. They were underweight. Now they are not underweight."

Speculators have slashed their bearish yen bets in recent weeks, bringing net short positions in the yen to $6.01 billion, the lowest since January and below a seven-year high of $14.526 billion in April, the latest weekly data from the U.S. market regulator showed.

Kit Juckes, chief currency strategist at Socie ́ te ́ Ge ́ ne ́ rale, said: "You can't unwind the biggest carry trade the world has ever seen without hurting people."