Yen Carry Trade Unwind Could Spark Higher Stock Market Volatility

Tomorrow is the jobs report, and the market seems to have a strange way of expressing any sign of nervousness. The VIX 1-day rose on the day to 10.9. Maybe the jobs report won’t matter. The jobs data has been so bad for so long that it may no longer matter. Hey, the unemployment rate could even fall because more people simply decide to retire and leave the labor force.

What it does suggest, though, is that the odds of a post-report volatility crush tomorrow are very low.

In other news, the yen strengthened on the day, with USD/JPY falling by 1.85% as traders added to bets that the BOJ will hike rates. I mean, they probably should have been raising rates faster quite some time ago. But now they are going to get serious. OK.

Anyway, given that USD/JPY is falling, I thought I would bring back the three-month implied correlation chart. In 2024, COR3M bottomed on July 3, and USD/JPY peaked a week later, on July 10. In 2026, COR3M bottomed on July 10, and USD/JPY peaked on July 28, less than three weeks later. Twice in a row, the low in implied correlation has marked the top in the dollar-yen. Chance? Maybe. But it is getting harder to argue that.

But the 60-day rolling correlation indicates a relationship between the two. If that relationship persists, then a stronger yen could lead to higher implied correlations and, ultimately, higher index volatility.

The relationship exists across the different yen FX pairs, with AUD/JPY being another important FX carry-trade pair. This is a weekly chart going back to 2006. The COR3m is inverted to make the relationship easier to see, while the 12-week rolling correlation roughly corresponds to a 60-day rolling correlation.

The point is that, over nearly 20 years, this relationship has predominantly existed in a negative-correlation regime, with spikes into positive correlation relatively rare. We are in one of those positive-correlation periods right now, and it appears to be rolling over. The 12-week correlation peaked at +0.7 in July and has already fallen to +0.12.

The last time it rolled over like this, in the summer of 2024, it went from +0.6 to -0.9 in about eight weeks. That was also the window in which AUD/JPY fell from 109 to 90. So, it is more likely than not that the relationship inverts again and returns to its historically negative regime. And if the 2024 sequence is any guide, that process may already be underway.

And if that happens, the BOJ will, yet again, have an excuse to pause its rate-hiking cycle.

-Mike

Michael Kramer publishes independent macro and options research read across 10+ platforms and by institutional desks.

For institutional partners: research syndication, licensing, and bylined or white-labeled commentary for platforms, brokers, and publishers.

Inquire →

Glossary by ChatGPT

AUD/JPY — The Australian dollar/Japanese yen exchange rate, commonly associated with global carry-trade activity due to differences in interest rates and risk sensitivity.

BOJ — The Bank of Japan, Japan’s central bank, responsible for setting monetary policy and benchmark interest rates.

Carry trade — A strategy that borrows in a lower-yielding currency to invest in assets or currencies offering higher expected returns.

COR3m — A measure of three-month implied correlation reflecting the market-implied relationship among individual components of an equity index.

Implied correlation — The options market’s forward-looking estimate of how closely the components of an index are expected to move together.

Negative-correlation regime — A sustained period during which two variables tend to move in opposite directions.

Rolling correlation — A correlation coefficient recalculated continuously over a fixed historical window to track changes in the relationship between two variables.

USD/JPY — The U.S. dollar/Japanese yen exchange rate, representing the number of Japanese yen required to purchase one U.S. dollar.

VIX 1-day — A Cboe volatility index designed to measure the market’s expectation of S&P 500 volatility over approximately the next trading day.

Volatility crush — A rapid decline in implied volatility, often occurring after a significant scheduled event or uncertainty has passed.

Disclosure

This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.