Delphi's Office Hours (6th of August, 2024)

Join us for this month’s episode of the Office Hours, where Ceteris, Kevin, Jason and Duncan digest this week’s big move in the markets.

Was it all macro led due to the bank of japan hiking, does dispersion get even worse from here, and what’s the outlook into year-end?

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Transcript:

[00:00:00] Ceteris: Hello everyone. Welcome back to another episode of office hours. Um, we’re going to be doing something a bit different this week. We’re mostly going to be talking about everything that’s kind of transpired over the last, I guess, week, but more specifically last couple of days. Um, you know, we saw like PTC go under 50 K ETH.

almost under 2k sold out to like 110 just a lot of selling all this yen stuff. Um, so for this episode, we’ve got a good, we got a good diverse cast here. We got myself, we’ve got Jason, of course, head of markets. We’ve got Kevin, uh, Chief janitor, I think is his title. And we’ve got Duncan, the gem hunter. We brought Duncan on because you know, when you have these crazy sell offs, everything kind of gets sold.

And then one thing you always like to look for, or at least I always like to look forward. I have some Excel files that will kind of walk through just like kind of what goes, what gets like bit off the bottom, you know, like off the lows it’s always. Kind of important. So I think to start it, we want to start with Kevin to just kind of get like the overall high level situation of what happened.

Um,

[00:01:13] Kevin Kelly: yeah, so it seems like everyone’s become an expert on. The yen carry trade overnight, right, which is the beautiful thing about this space. Um, but for good reason, I mean, it is a really big part of, I think the volatility we’ve seen over the last couple of trading sessions. Um, long story short, the yen carry trade has been increasingly, it’s been popular for Years and years now, but it became increasingly popular really, I would say over the last probably two, roughly two years, 18, 24 months.

Um, and the, in essence, you know, was been taking places and carry trades are very popular and trad fi is you essentially borrow in a low yielding. Currency, right? So the Japanese yen being the most popular one. Um, and you take that money that you borrow and you essentially invest it either in other currencies and their debt instruments that pay higher yields, um, or you actually can invest those in foreign assets.

Right? And so the reason why. That second part is important is, um, a good amount of, you know, this, yeah, encouraged, right. I think has certainly shown up in some of the buying demand for us equities. It’s not the primary or only driver, but I think it certainly has, um, been a key factor in some of the reality that we’ve seen over the last, you know, a couple of years and in us equities and even us big, big cap tack.

Um, And I’ll show you a couple of charts that really, I think, get to the heart of this. This first one really just shows, just to lay the kind of groundwork, you know, the yen versus the U. S. dollar, and I’ve got this kind of inverted, um, versus the speculative positioning on futures positioning on the Japanese yen.

And so basically what all these red bars mean, and the increasing red bars, It’s kind of a proxy for, uh, speculative positioning and how popular this kind of yen carry tree really started to get right, especially again, throughout 2023 and even big time in 2024, what we’ve seen over the last couple of sessions, and really I would say over the last two weeks is probably a good starting point.

Is as that got really popular and the yen really fell off a cliff, right? We’ve talked a bunch about this in our research. Um, it got to a point where you had a surprise Bank of Japan rate increase. You had at the same time, increase expectations for, uh, the Fed actually finally, uh, doing rate cuts right as early as September.

Um, and you had this last week, a bit of a, uh, growth scare, let’s call it so far, or increased. A sentiment that the U. S. could be heading towards a recession that all kind of transpired into, um, and intervention from the Ministry of Finance in Japan to try and prop up the end all this kind of, uh, combined to give the Japanese yen a bit against the dollar.

And that’s really what you see in this white line bottoming here. The rebound in that has started to cause some serious havoc in global markets because as that carry trade on lines. The assets in which, uh, people have, you know, taken that money that they they borrowed in Japanese yen and have bought with, they potentially have to sell in order to repay either the.

Uh, amount that they borrowed the loans that they borrowed or have to top up their margin because they’re getting margin calls. So, in essence, the unwinding of this carry trade has started to cause quite a bit of havoc. Um, and I think it’s been really at the center of a lot of the initial volatility that we saw, because when you see, you know, Japanese equity is falling 12 percent in a single day.

Those are moves. Those are extreme, extreme moves, right? We’re maybe jaded to it because in crypto at 12 percent a day, yes, it hurts, but it’s kind of like any other Tuesday. You don’t typically tend to see those types of moves in traditional markets, especially big equity benchmarks. And so there’s evidence that this character online is, is underway.

What’s important about this data that we’re looking at here is this is actually operates on a bit of a lag. So the latest data we got was this past Friday, and that’s really only through, I think last Tuesday. So what’s going to be really important is this coming Friday. We’ll get an update on where this kind of speculative futures positioning on the end sets.

I expect this to continue to this point, red bar to get smaller, right. And decline as this carry trade has continued to unwind. The question right now I think is whether or not we’re at the kind of tail end of this carry trade online or if we have more to go. I personally sit at the camp that you think about the size of this trade and this is really just a small part of this market, right?

This is more kind of hedge funds or more speculative positioning. When you look at the amount of outstanding, um, JPY loans that Japanese banks have made, for example, I mean, you’re talking about, you know, a trillion, trillion dollars plus equivalent. And outstanding loans. These are this has the potential to be a even bigger, uh, unwind.

The question now is, you know, whether we see that here, if we start to see the market stabilize a bit, the second chart I’ll show and then I’ll get to you guys. There’s a bunch of stuff. I’m sure we’re gonna go through, but I showed this one last week on a, um, our pro crypto insiders talk that round. I do every month that pro members obviously have access to as well.

It’s on our portal. I think the real concern is what this chart shows, which is you’re looking at that same white data line is net, uh, speculative futures positioning and again, and that’s inverted versus the NASDAQ 100, right? So kind of your, your big tech, your higher beta, you know, growth, the, uh, us equities, and what you can see is that again, the year of your changes in these have a pretty.

Close correlation or tight relationship with one another. And so the, the idea is if you continue to see a pretty big unwind in the, in the end carry trade, will that actually pull back or, uh, cause further selling in some of these foreign assets, us equities, again, being not the only one, but a popular one, I think that’s the concern that’s on everyone’s mind right now is it’s, it’s difficult to ascertain, you know, how much selling is left to go and how much this unwind is left to go.

And if, and when that’s. That potential unwind stops, um, which I think again is why you see volatility up while you still see a bunch of uncertainty even today after the big moves yesterday, um, is there isn’t really a definitive point in which you can say, okay, you know, we’re confident that the worst is necessarily behind us.

[00:07:32] Ceteris: Yeah. Also on the unwind. I’d like, I saw some of these people were like pricing at emergency cuts and all this stuff, and I saw people calling for it, but if the fed reduces rates further, like that just makes that unwind even harder. Right. Like that’s just, it makes things worse. Yeah. It makes things worse.

And so it’s like, It’s not that easy. Everyone just loves things to like love rate cuts and that just solves all the problems but that this is actually one where it like mathematically makes it a lot worse if the if the U. S. were to start cutting aggressively because then you just see a stronger and stronger Yen, right?

So,

[00:08:12] Kevin Kelly: yeah, and that’s what essentially the chart shows. And we put this in our, one of our latest, uh, markets reports. We were talking about this U S Japan kind of China conundrum. And to your exact point, if the U S cuts rates, right. Part of the reason why this carry trade got so popular was that sizable rate differential, where you can borrow cheap in yen and you can invest in, let’s say, call it us treasuries, right.

They’re earning, you know, four and a half, 5 percent yields us dollar based yields. As long as the yen continued to be Relatively stable. And as long as Japanese rates remained extremely low by global standards, this trade works out great. What you’ve basically seen over the last 2 or 3 weeks is the reversal of all those factors, right?

So, what this shows is that rate differential between the US and Japan versus again, the US dollar Japanese cross rate. It’s your point. You see rate cuts and, and to be fair, the market has started to price in some pretty aggressive rate cuts, whether or not it’s an emerging couple for September. I don’t think the federal do that unless you see things actually break down in the treasury market.

You see dysfunction in credit markets. That’s really what forces the feds hand, not no large equity sell off. Um, but there are potential downstream consequences of asset prices falling that can wind up. Impacting credit can actually wind up spilling into the real economy in terms of, you know, reducing consumer sentiment, potentially reducing consumer, um, consumer spending, which is the kind of core engine or the big engine that drives the U.

S. economy. So, as you kind of play down these kind of macro rabbit holes, there are downstream or domino effects that, you know, the latest volatility we’ve seen can spill over into. Whether or not that happens before September, I don’t necessarily think it would have, we’d have to see something pretty dramatic break or start to break down before you actually get a Fed emergency cut.

And I don’t think they should. But the question is now, you know, how, how narrow will that rate differential gap get? And will that cause a further unwind in this popular yen carry trade? Um, or will we see markets stabilize in that yen carry trade? Maybe it’s not to the extreme, you know, that we saw it build up to, you know, in July of this year, but we’ll still be relatively Popular, I guess you could say, and won’t cause this further volatility.

[00:10:31] Duncan Reucassel: Yeah. I have some questions for you. I guess the first one is I saw this on Twitter and I thought like, logically it made sense, but basically they said like this trade got really ahead of itself, this yen carry trade. And like the Japanese yen was basically just going straight down. Um, so doing a move like this kind of flushes out the leverage, but Japan’s like fundamental situation doesn’t change.

Like, you know, they’re in the most indebted, right? Country in the world. I think it’s like 260 percent of GDP. Um, they’re going to need to infl