Image Source: Pixabay

The Economics 101 junior trader approach to JPY rate differentials is the least compelling reason to go long on the Yen. The tech market sell-off reinforces the liquidation of JPY-funded carry trades, so the focus is more on volatility than basic economic principles.

If risk continues to deteriorate at the pace it has this week and the VIX keeps climbing, we might see USD/JPY break below the 200-day moving average of 151.50. This level was breached at the end of last year and the start of this year, but it only lasted briefly before USD/JPY hit new highs. This time around, however, it’s different!

Reversion traders aren’t piling into JPY because they anticipate a modest 15 basis point rate hike from the BoJ. Instead, they’re gearing up for a major tech meltdown, which would likely trigger a further liquidation of those elevated yen-funded carry trades, which is well underway. After all, correlations like this typically don’t lie.

Folks on the Street know that August can be a tricky month. For one, the VIX tends to show some severe upticks, and when the VIX starts sizzling, stocks often fizzle.

Volatility is closely tied to market liquidity. When Wall Street traders are on vacation, liquidity can dry up, leading to exaggerated price swings and increased volatility. This creates a dreaded negative feedback loop: if volatility spikes, a more liquid market might absorb the shock better, but in thin “ dog days of summer” markets, the impact can be far more pronounced. In other words, when liquidity is thin, even a slight lean toward negativity can send seismic shockwaves tremoring through the market.

Historically, the first 15 days of July have been the best two-week trading period of the year for equities since 1928. However, July 17 marked the local top for the month, and since then, we've been trending lower into the dog days of summer—a classic territory for bear sightings.

Equities also face the risk of outflows as we approach the presidential election cycle, which typically favours the bears.

We might be just witnessing the early stages of a dreaded "volmaggedon."

So, what’s the takeaway? Keep a close eye on the VIX—the go-to fear gauge—showing moves that suggest systematic and algorithmic traders are firing up their volatility engines again. We’re leaning heavily towards a risk-off stance for August, especially with CTAs all in and no room to buy the dip. Tread carefully out there.

For those looking to manage risk, consider a monthly US commercial paper at 5.25%, which looks promising. Long JPY remains a solid hedge against the ultimate carry trade unwind, especially if leverage becomes a concern in a high-volatility, low-liquidity summer scenario.

As for gold, despite the temptation to dive into long paper positions at current levels, I adhere to a 40-year rule of thumb: never enter medium-term speculative trades on the last Friday of any month.

And as always, the sun seems to shine on Mondays! Have a good weekend.

More By This Author:

Stocks Have Ventured Into Choppier Waters
Forex: Yen Moves On A Nudge From Above?
A Hyperscalers Hiccup Sends Investors Into A Tailspin