As the Japanese stock market fell more than 2% at the beginning of today's trading session, the controversy over whether the "big cap" of yen arbitrage trading has ended has once again escalated. However, as of the latest press release, the Japanese stock market has reversed its decline to rise again.
So, what is the current stage of the "big picture" of arbitrage trading?
An interesting news is that JPMorgan Chase changed its statement in its latest report, stating that three-quarters of arbitrage trades are currently closed.
Morgan Stanley strategists Antonin Delair, Meera Chandan, Kunj Padh, and others wrote in their reports to clients. Since May, the G10 currency, emerging market, and global carry rate baskets have been continuously declining, with a drop of about 10%, erasing this year's positive returns and significantly reducing returns since the end of 2022.
These strategists point out that the spot portion of the global carry basket indicates that 75% of arbitrage trades have been liquidated, although this is not a completely reliable indicator.
They also stated that although there are fewer global central bank policy meetings in August, the window may be favorable for repricing the carry trade, but due to the US election and the prospect of declining US bond yields, this strategy is not attractive in the medium to long term.
This statement clearly goes further than the closing progress mentioned by Xiao Mo the day before. At the time, Arindam Sandilya, co head of global forex strategy at JPMorgan, stated that the "yen arbitrage closing" that had caused a stock market crash in the past few days may still be far from over. We believe that at least in the speculative investment industry, the closing of arbitrage trades may only be completed by 50% to 60%
In fact, the extent to which yen arbitrage trading has been closed has always been a controversial topic in the Wall Street investment banking circle. For example, as we introduced yesterday, Goldman Sachs' view is actually much more optimistic than Xiao Mo's. Goldman Sachs trader Anton Tran believes in a latest report released on Tuesday local time that the pressure to close short positions in the yen has actually been largely eliminated, which means that the "pain of arbitrage trading" is about to end.
And the reason why this series of market controversies - which no one can convince anyone of - is itself due to the difficulty in clearly quantifying the scale of arbitrage trading and how much capital needs to be liquidated from the source.
Financing arbitrage trading refers to investors borrowing currencies from countries with lower interest rates, such as the Japanese yen, and then using these funds to invest in currencies or related assets from countries with higher interest rates, such as the United States and Mexico. In recent years, due to ultra-low interest rates in Japan, the Japanese yen has been the most popular financing currency. After several years of active interest rate hikes by Western central banks to combat inflation, Japan finally bid farewell to the era of negative interest rates in April this year.
The specific scale of arbitrage trading is difficult to guess
However, it is difficult to trace the scale of arbitrage trading because currency trading cannot be centrally tracked like stock market trading. And almost all cross asset market participants, from hedge funds, family offices, private capital to Japanese companies, use this type of transaction.
Of course, there are still some methods available in the market to evaluate its popularity.
One method is to view open contracts tracked by the US Commodity Futures Trading Commission (CFTC). According to CFTC data, as of early July, hedge funds and other speculative investors held a net of over 180000 contracts betting on a weaker yen, valued at over $14 billion. By last week, such positions had dropped to about $6 billion.
Of course, as Chris Turner, Global Head of Markets at ING, recently pointed out, the foreign exchange holdings data tracked by CFTC is actually just the tip of the iceberg for yen financing arbitrage trading. In recent years, banks, asset management companies, and other institutions have also borrowed heavily in Japanese yen, and even the Japanese government can be considered a "player" in yen financing arbitrage trading in a sense, so the position data can only be seen as changes in popularity at best.
In fact, the exact number is likely to reach the level of billions or trillions. According to data from the Bank for International Settlements (BIS), as of March, the Japanese banking industry has lent approximately $1 trillion in Japanese yen to foreign borrowers, an increase of 21% from 2021. A significant portion of the growth in cross-border yen lending is in the interbank market, in addition to lending to non bank financial institutions such as asset management companies.
In terms of Japanese investors, as of the first quarter, the international net investment of Japanese investors reached 487 trillion yen - approximately 3.4 trillion US dollars, an increase of 17% compared to three years ago. However, most of this comes from foreign exchange reserves. The portfolio arbitrage trading of traditional asset management companies is not the biggest part.
Finally, there is another theory in the market that the scale of yen arbitrage trading has reached $20 trillion. But in fact, this number is somewhat ambiguous, measuring the total value of the Japanese government's balance sheet at around 500% of GDP or $20 trillion. Although the Japanese government is indeed the largest yen arbitrage trader in the market in practical terms, including all of this number is still somewhat exaggerated
UBS global strategist James Malcolm estimated this week that the size of yen arbitrage trading established since 2011 is about $500 billion, with approximately half of it growing in the past two to three years. He believes that investors have closed approximately $200 billion in positions in the past few weeks, accounting for about three-quarters of the positions he ultimately expects to be closed.
Finally, regardless of the scale of yen arbitrage trading in the market and how many have already been closed, a preliminary signal that can be recognized is that with the Bank of Japan's "surrender" promise yesterday that it will not naturally raise interest rates in the future when the market is unstable, the initial wave of arbitrage trading "big market" shock may have gradually subsided. Even if there are still some liquidation actions that have not been completed, they may unfold in a more gradual manner.
In fact, although the three major US stock indexes fell across the board again overnight, their correlation with the Japanese yen exchange rate is not very strong anymore. The well-known financial blog website Zerohedge has stated that there is a decoupling between the two. Although the US stock market fell yesterday, the rebound of the Japanese yen after a sharp decline during the Asian session was not significant.