The Bear Room, page-223

The immediate issue is the collapse of the $US/Yen carry trade.

Call it the Bank of Japan butterfly effect. The central bank’s Wednesday’s rate hike to 0.25% from 0% to 0.1%, along with commentary suggesting more tightening to come, has spurred financial convulsions in Japan and beyond: The Tokyo stocks lost an eye-watering 7% today following Fridays 6%% drop to mark its worst two-day showing since the 2011 Tsunami, while the MSCI Asia Pacific Index sank 3.5% Friday, its largest daily decline in three-and-a-half years.

The violent response to such an ostensibly modest policy tweak is instructive, the recent trend reversal reverberates far and wide. Thus, the yen’s explosive, 9% four-week snap back against the dollar, in the wake of a near 60% selloff spanning the start of 2021 through early July, puts the big hurt on carry trade positions, in which investors borrow low-yielding yen to invest in higher yielding jurisdictions such as the U.S. and Australia

It's the rate of change of interest rate differentials that matters, if the BoJ are stepping up the pace of rate hikes relative to market pricing, and if the Fed is also becoming in play for rate cuts here, then the pressure on the carry trade increases painfully. As an influx of income-seeking foreign capital has provided a persistent tailwind for U.S. stocks, the unwinding of that dynamic reciprocally presents very bearish implications.

The now evident vulnerability of U.S. and Australian equity prices to a rise in the yen exchange rate warns of the consequences for U.S., Australian asset prices and developed-world asset prices in general.

Be afraid, be very afraid...