August 8, 2024: Volatility Awakens from Its Slumbers

This Monday’s trading day offered two historic market moves. The 12%, single-day drop in Japan’s Nikkei stock-market index was the largest decline in that index since 1987. Domestically, the so-called “fear” gauge—viz., the Chicago Board of Exchange’s Volatility Index (the VIX)—had its highest daily spike since that index’s creation in 1990. That spike was higher than daily moves during the Great Financial Crisis of 2008 and during the economic shutdowns of the Covid-19 pandemic.

Binding the two landmark events is the unwinding of a popular trade, a trade that had grown in popularity during a period of ultra-low interest rates. Borrowing in currencies where interest rates were low or even negative (such as the Japanese yen) and investing where return prospects were greater (such as U.S. technology stocks) offered investors prospects of capturing positive “carry” between the two assets. The assumption, of course, was that the relationship between the two assets would hold.

Last week’s news on the U.S. economy—and the Bank of Japan’s decision to raise interest rates—threw that assumption into question. Investors adjusted positions quickly to prepare for lower domestic rates in the U.S. and more expensive funding sources from abroad. The size of Monday’s volatility spike show the risks of crowded trades when they unwind.

Weekly Market Update: August 7, 2024