Ritesh Jain, former chief investment officer for BNP Parisbas and Tata and founder at Pinetree Macro, spoke to Investment Officer about Monday’s market crash and highlighted the critical role of BOJ policies and their significant impact on global liquidity and risk appetite. “It is reasonable to say that the most important central bank in the world is BOJ and not Fed because BOJ policies have led to massive asset inflation across the world.”
Jain, who has managed billions in assets and is globally recognised as a leading influencer in the fields of economy and finance, observed that the leveraged carry trade’s recent unwinding has sharply increased margins, with the US VIX index spiking from 16 to 65, signalling rising market volatility. Carry trades have long been popular with Japanese investors and hedge funds who borrow cheaply in yen and then invest in US tech stocks.
The BOJ’s unexpected interest rate hike, coupled with the yen’s appreciation beyond the 150-mark, triggered a massive sell-off, reflecting the market’s aversion to sudden policy shifts. “Without a stabilisation in volatility, the carry trade is unlikely to recover soon,” Jain cautioned, pointing to the uncertain outlook for investors navigating the yen’s erratic behaviour.
Glimmers of hope
The broader implications for global markets, particularly emerging economies, are significant, Jain said. Still, he sees a glimmer of hope in the stability of the DXY dollar index, which measures the value of the dollar against a basket of six foreign currencies: the Euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona, and in high-yield spreads. Without these two factors,
However, companies with unhedged yen-denominated debt face potential margin calls and severe losses if the dollar strengthens or bond spreads widen.
Jain said that in such a volatile climate, traditional hedging strategies might be expensive, advocating instead for a strategic shift to cash. He stressed the urgent need for clear and consistent BOJ policies to restore market confidence and stabilise the future of the carry trade.
IO: What long-term implications do you foresee for global markets following the recent unwinding of the yen carry trade, particularly in terms of liquidity and risk appetite? Could this lead to margin calls and disruptions in financial flows?
RJ: “The leveraged carry trade has already been unwound in my view. We are witnessing an increase in margins across the board as margins need to consider asset volatility. The increase in US VIX from 16 to 65 has already led to the system getting derisked to a large extent. The long-term view on return of carry trade depends upon BOJ policies. If they are OK with Yen appreciating, then Japan will again go into deflation, or they can inflate away the debt by actively promoting JPY depreciation. Without explicit Central Bank policy support the volatility could remain high for some time hence the risk appetite could take some time to come back.”
IO: How might the Bank of Japan’s recent policy changes, including the interest rate hike and reduction in bond purchases, influence future carry trade strategies and global investment flows?
RJ: “The market does not like uncertainty nor do they like surprise. Honestly 0.25% increase in BOJ policy rate from zero bound is not a big deal but BOJ did not prepare the markets for this hike. The complacency and leverage led to this unwound and once Yen started appreciating beyond 150 major derisking happened with whatever can be sold was sold. I do think that in the short term unless volatility comes back to within range, carry trade will not be back in a hurry.”
IO: Given the historical context and current developments, what are the potential risks and benefits for investors, also considering secondary, spin-off risks?
RJ: “I am looking at DXY which refuses to go up, also high yield spreads which refuse to blow out, and oil which is down a little but not too much. All this is good news for emerging markets as lower US dollar and lower US bond yields are like life blood for emerging markets. The risk is if the dollar starts strengthening here or bond spreads blow out then it would be reasonable to say that this correction is turning into a contagion. The spin-off risk is in unhedged JPY denominated debt which is on corporate books across the world. Those corporates would be getting margin calls and possibly booking massive losses on their JPY denominated currency loans.”
IO: In light of the significant market reactions, what strategies would you recommend to hedge against the volatility caused by sudden policy shifts in major economies like Japan?
RJ: “The volatility is so high currently that it is prohibitively expensive to do hedging. If you feel the need to hedge, then better to sell the assets and raise the cash. I would wait for Yen to stabilise and BOJ to show its cards before deciding whether to exit Japan or increase the exposure, but one thing is clear. JPY depreciation is no more a one-way street, and we are in a market where DLR/JPY could move both ways violently and hence it would be some time before carry trade is back.”
IO: How do you expect the Federal Reserve’s monetary policy decisions, such as the hinted rate cut, to interact with the Bank of Japan’s policies and affect international investment dynamics? Should the BOJ reverse its decision?
RJ: “If the Fed were to cut rates by 50 basis points in September and continue to be dovish then interest rate differentials between US and Japan will come down. This will lead to a reduction in currency volatility. I think till we see that central bankers should keep DLR/JPY in range by actively intervening in the markets. It would be foolish for BOJ to reverse its decision because then it would look like a panic reaction and the market will get nervous at this flip flop by BOJ.”