BKLN
The unwind is comingJPYUSD broke out today with a huge 1% move to break out of a 4 year long wedge. This is a bit of a technical move, but it has loads of fundamental implications.
Before I go into detail, note that before and during every major market breakdown, JPY spikes, at least in modern times. It has a reputation as a safety currency / safe haven due to this reputation. The reason being that Japan has had extremely low interest rates for a very long time, making it an ideal currency to borrow in, then purchase foreign bonds. IE, a carry trade. The reason it's a safe haven is that when risk starts to occur, traders who have huge positions built up buying foreign fixed income of any variety will sell those positions, and will re-purchase their Yen as they do so.
The problem here is that this can become a bit of a feedback loop. As we see liquidations in these bond positions, this will force more traders to cover, resulting in the Yen rising more and more. This started to occur in 2007 before the financial crisis.. it was actually one of the dominant stories of that era (see www.marketwatch.com) . If only more people knew what this meant for overall financial markets.
US High Yield
One of the biggest risks that has been identified by many people over the past 1-2 years has been the pervasive reach for yield. There has been a significant bubble of corporate debt built up over the past decade, and a lot of it is covenant light, or poorly rated. When the yen rises, corporate debt gets liquidated... Turns out, a significant portion of the buyers of US corporate debt have been asian buyers who's own sovereign bonds are negative yielding. There have been recent stories that many of these purchases have been made un-hedged even...
So long story short, the JPYUSD carry trade can be used to proxy risks to the US corporate debt bubble, and by association, the global reach for yield. This is a trade that can seriously unwind... big potential for negative convexity here in my opinion. IF this continues to break to the upside, it'll cause a lot of issues in markets globally, but watch the high yield space (BDC's, corporate bond etf's, etc).
Leveraged Loans | Corporate Risk Premium Crisis?Many of you may not be familiar with leveraged loans and the ETFs that have become available to investors through funds over the last few years, but they are important to understand in order to have an edge over the rest of the markets these days - whether that's traditional equities, commodities, derivatives or crypto - as wealth preservation will be a big theme during 2019/2020. Investors have been driven into leveraged loans and related products sharply since the Financial Crisis as a result of record low interest rates in developed markets caused by experimental monetary policy; investors have been desperate for yield! And so we have seen very low risk premium spreads between "risky" junk paper and "risk free" treasury paper as a result of distortions in the marketplace. This spread is currently in the single digits, but during the Financial Crisis - when credit flow started to freeze - the spread skyrocketed into the 40 point range! Treasuries have only room to go lower in the event of a credit crisis and so one can imagine that risky corporate paper will be the victim of such a scenario as companies no longer get access to cheap credit. This will put huge pressure on corporate yields, resulting in defaults and deeply discounted paper.
FYI: The Quantity Theory of Credit is my theoretical and empirical inclination.
Anyway, keep an eye on leveraged loans and the ETF carrying them. Due to the way these ETFs are held by funds they also carry significant redemption risks, which can cause a run on the funds that issue them and cause funds to panic sell to meet redemption requests from investors. I'm sure there are a few strategies one could devise to take advantage of such a scenario ;)
