Margin of error. The steepest market falls in recent times have been due to a dizzying array of sources: the pandemic, the war, UK pension funds and most recently The combination of a poor US jobs report and the dismantling of a popular investment strategy focused on the Japanese yen. However, behind all of them was a common trend of highly leveraged market players, such as hedge funds, struggling to meet margin calls. There are many reasons to think this will happen. It keeps happening.
Researchers at the Bank for International Settlements have repeatedly noted that caught attention to the worrying frequency of what they call “procyclical deleveraging.” On Tuesday, released A first report from August 5th sudden accidentThe triggers, they note, were seemingly minor: a U.S. jobs report on August 2 that was bad but It is not disastrousand the broader context of a marked asset Aggressive turn For the Bank of Japan, that somehow turned into a global selloff that sent Japan’s Topix index tumbling by more than a tenth and wiped $1 trillion off the valuation of once-popular AI and technology stocks.
Context explains the moves. For a start, hedge funds were highly leveraged: a gauge of US hedge fund debt had soared to its pre-pandemic highs. Meanwhile, investors increased their use of a strategy known as the carry trade, which involves borrowing in a low-rate currency like the yen to invest in assets denominated in high-rate currencies like the Mexican peso. BIS researchers repeatedly try to quantify this trade, arriving at a “rough” estimate of $250 billion before the sell-off. They believe that, on its own, is likely to be too low.
Hedge funds and other investors often execute this strategy through derivatives. When positions lose money, or when market volatility increases, brokers and clearinghouses often ask investors for higher margin levels, which reduces risk. Hedge funds and other market players therefore tend to need cash in the midst of a panic, forcing them to sell unrelated positions just to meet margin requirements on losing bets. That explains how a currency-linked trade and US stocks got tangled up. A bit of volatility led to margin requirements, which led to broader asset sales and higher volatility. In March 2020 and September 2022, a similar self-reinforcing cycle hit the US and UK government borrowing markets, forcing central banks to limit the price collapse by buying assets.
Regulators are wary of the recurring problem, which is linked to a post-2008 effort to shift risk away from banks and into markets. A triumvirate of the Basel Committee on Banking Supervision, the Committee on Payments and Market Infrastructures and the Council of the International Organization of Securities Commissions in January recommended Various measures to make clearinghouse margin calls more predictable. Transparency is helpful, but it is difficult to see how it would change the fundamental dynamics. Margin calls continue to blow up markets, and there is no end in sight.
Context news
Yen loans to financial market players other than banks reached $250 billion in March, researchers at the Bank for International Settlements said in a bulletin published on August 27. The figure is a rough indicator of the size of the popular yen carry trade, which involves borrowing in the low-yielding currency to invest in a high-yielding one. A breakdown in the trade contributed to market chaos on August 5, when Japanese and global stock markets fell. BIS researchers concluded that the succession of margin calls helped spread the problem, as investors sold as much as they could to meet the new higher margin requirements.
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