Over the last few days, the sudden volatility in the markets has resulted in clients, friends and family (especially my wife) all wondering what just happened, and more important, what happens next. For sure everyone by now has read that one of the culprits was the action by the Bank of Japan (BOJ) last week to raise interest rates by about 0.25%. But how does that small increase in rates result in trillions of wealth being lost? In this note, I will connect the dots in the simplest possible way.
I have been writing about the carry trade and its connection to volatility for many years now (see my paper on the topic published in the Journal of Fixed Income here which explains the connection between currency carry and currency volatility), and also the impact of negative carry on investments here.
The full note on this important topic can be downloaded at this link: LTA Thinking – How The Carry Trade Crashed The Market, Again, And What Comes Next