It has become quite clear that the path of least resistance for the spectrum of higher-risk investments leads lower. The markets’ response to Friday’s unquestionably impressive US GDP result for the fourth quarter is quite telling as both equities and commodities continues to slide. Indeed, S&P 500 yielded the first three-week losing streak since July and the biggest monthly drop since February of last year. Meanwhile, a UBS/Bloomberg gauge of commodities’ performance capped the largest 5-day loss since the first week of September 2009 and the worst monthly drawdown in over a year.
Such blood-letting bodes ill for carry trades, a good bit of which are funded with capital borrowed cheaply in Yen. Indeed, a Deutsche Bank index tracking G10 FX carry trade returns has a near-term correlation reading of 0.97 with the MSCI World Stock index and 0.88 with the aforementioned commodities benchmark. As traders exit carry trades along with bets on other risky assets, they must buy back Yen to repay the borrowed capital used to established the positions, sending the Japanese unit broadly higher.
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