The Yen Carry Trade Unwind May Have Come Back To Life

This past week didn’t go as expected despite reserve balances falling to around $3.13 trillion. The JPM Equity Fund collar had too much of an impact, causing the index to get stuck between 5725 and 5750, preventing any meaningful breakout. That was one reason the market gave back all of its gains on Thursday despite the strong open.

However, the collar will be removed on Monday, and a new one will be created, eliminating the mean-reverting forces tied to the 5750 level. This should also result in a rise in implied volatility, especially with the upcoming data being more crucial than ever.

On top of that, Japan equity futures dropped sharply on Friday following the announcement of the new Prime Minister, who is expected to be more in favor of normalizing rates and pursuing a more balanced budget. The news came after the close of regular trading, with Nikkei futures in New York down about 6% by Friday evening.

Japan’s market can be unpredictable. I’ve traded in Japan during critical moments, such as the financial crisis, the Fukushima disaster in 2011, and the election of Abe in 2012. The market can move quickly and take unexpected turns. So, while futures were down 6% in after-hours trading, I’m very curious to see how it unfolds, and I’ll be closely watching the market overnight—especially the yen.

The yen strengthened materially as markets bet on the opposition leader winning the prime minister position, leaving them wrong. This led to the USDJPY strengthening by 1.8% and the CADJPY by 2.1%. These were significant moves, and in the process, it appears that the USDJPY fell back to its 20-day moving average and its 10-day exponential moving average. More importantly, it also seems to have broken below a bear flag, setting up a test of support at 141.85 and then 141. Once 141 is broken, the odds of a move down to 138 or so seem to increase significantly.

The same can be said for the CADJPY, which appears to be on a short-term path to around 103, with the potential to head to 100.

This has significant implications for U.S. markets. If USDJPY heads toward 141 and USDCAD moves toward 103, it would mean USDCAD weakens to 1.369 from its current 1.351. This would suggest that USDCAD has potentially “bottomed.” As it weakens further, thus turning higher, it signals that the SPX may have put in a short-term top and is likely to move lower.

It would also probably mean a higher vix index, as the USDCAD has a strong relationship with the VIX. By the way, the lines drawn in the SPX/USDCAD chart above have been unaltered in the chart below for the USDCAD vs. the VIX.

Meanwhile, Nvidia will provide critical insights into market conditions this week. A lower Nvidia would likely indicate that the yen carry trade is unwinding. Nvidia has touched the upper trend line three times and is currently testing the 10-day exponential moving average. A potential touch of the lower trend line comes in around $111, which is something to keep an eye on.

I also believe that Wingstop is another carry trade play, as the stock has mirrored shifts in the USDJPY since October 2023. The stock appears to be forming a potential double top, with gaps to fill at $395 and $366.

-Mike

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