Weston Nakamura on Yen Carry Trade Risks, Japan's Currency Interventions, and Global Market Implications

Unlock the secrets of the global margin call and understand why the yen's strength could be a critical point of failure in finance with macro researcher Weston Nakamura. In this fascinating episode, we uncover the latest developments in the yen carry trade and its ripple effects on markets like the NASDAQ and Russell 2000. Nakamura provides a deep dive into the Japan Ministry of Finance's interventions and their knock-on effects, drawing intriguing parallels with the post-1990s bubble burst era in Japan.

We also revisit the infamous 2008 financial crisis through the lens of the carry trade, particularly focusing on the AUD/JPY currency pair and its significant role in market volatility. Listen as we dissect the monetary policy mismatches between Japan and other global economies, and how geopolitical tensions and rising oil prices are adding layers of complexity to Japan's economic landscape. Nakamura explains the profound impact of these dynamics on the Japanese yen and the broader economy, especially given Japan's dependency on imported oil and the socio-political ramifications of rising energy costs.

In the latter part of the episode, we explore the unique investment behaviors of Japanese NISA account holders and their growing interest in U.S. equities amidst a depreciating yen. Discover how this shift is influencing global equity markets, particularly the S&P 500 and NASDAQ, and consider the potential for a reverse carry trade scenario. We also discuss the broader market trends driven by systematic and CTA flows, and what the future holds for Japan's interest rate policies under the Bank of Japan. This episode is packed with expert insights and analyses that will keep you well-informed on the shifting tides of global markets.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Transcript

Speaker 1: 1:14

my name is michael guy at, publisher of the legal report. Uh, join me for the hour. Here is mr weston nakamura who, if you haven't seen his stuff, he's got some incredible research and analysis, phenomenal sub stack, and he and I have actually talked about the carrier trade before, uh, towards the end of last year as a very likely scenario. He and I think we're about the carrier trade before, towards the end of last year as a very likely scenario. He and I. I think we're both early but, as I emphasized, being early is not wrong as long as you don't short. That's the key to this stuff, which people don't seemingly understand. So, weston, for those who are not familiar with you, before we get into the heart of the matter, talk about your background. Who are you? What have you done throughout your career?

Speaker 2: 2:00

And what's the mood in japan right now? Um, start with the latter mood probably is what, um 1990, you know, uh bubble burst might have felt like, I guess I don't know. Um, yeah, hi, my name is weston aguilar, from across the spread. Um, I do macro research and analysis with an asia focus that relates to and impacts global macro markets, specifically from more of the DM US equity market, investors, lens. So when I talk about things like the Bank of Japan, the Yen, jgbs and stuff like that, I'm not talking to, like, jgb investors None of you are JGB investors, I would assume, and JGB investors probably don't listen to me.

Speaker 2: 2:31

Actually they do, but I'm talking from the point of why this matters to people and is being severely undercovered, and so therein lies risk and or alpha. So that's kind of my niche. I'm also a professional clown and so oftentimes I'll just throw in what I think is humorous. That's up for, again, the markets to debate. But yeah, that's pretty much what I do, and so I have a sub stack and I also have a YouTube channel as well, all right.

Speaker 1: 3:02

So I want to start with a softball question which is from YouTube. Did Japan just blow up the world? I mean, what is going on here? I mean I'm making light of it, similar to, by the way, when I when I was making light of it with david lynn in august, when I first brought up the whole thesis of the reverse character trait but I mean how serious uh is is. This is what's going on and we're getting to the background of it. But let's just talk about the here and now.

Speaker 2: 3:27

So, um, you started calling it, um, I don't know if it was you specifically, but you know I I associate you with the term uh, global margin call. I believe I've been saying the crowd strike. Jpy is the crowd strike of uh, of global markets, which is kind of the same thing. But you know, crowd strike for those who don't know, you know is a very recent sort of event where you have the single point of failure across all like IT systems and like took down, like you know, airline systems, like so many things are impacted. Jpy is that the JPY strength is currently that of markets and when you start, you know like you're seeing like risk off now.

Speaker 2: 4:10

But at first this was triggered basically on July 11th, on CPI Day. Us CPI comes in soft at 8.30 am Eastern Time. Then that initial knee-jerk move, a softer CPI would imply Fed rate cuts coming easier, financial conditions markets up, sort of thing, and so you saw NDX futures actually jump on that print. But then, about 13 minutes later, you saw dollar-yen go from about 162 handle down to like 157, half in span of a half an hour. That was a yen intervention, that was a Japan Ministry of Finance intervention, buying of dollars slamming down of USDJPY and that was also top tick for this kind of, you know, from that NASDAQ all time high moment as well, as you know, dollar yen as well as other various yen crosses, and from then on we were just kind of down and down, and down and down and that all stems back to patient zero, which is the end, carry trade being unwound. Yen strength, yen short, covering. This is position exiting right.

Speaker 2: 5:19

Um, and at that point, at you know, in the, in the first, like, call it two weeks or so, that wasn't again, it wasn't a risk off event because you saw the, the russell 2000, like outperforming the nasdaq by 20 percent or whatever the hell insane number. You know it was um, so, and outperforming I mean like actually rising, not like sinking, less so, um, that wouldn't necessarily be. Or like a risk off in the sense of um, obviously they're, you know, like equity, that's an equity, small cap index that's being bid up. Risk-off is what I'm talking about, like kind of what's happening in Japan right now, where it's just indiscriminate, anything, that is a stock ticker, I don't care what it is, where it was trends that had been existing prevailing, then reversing. So that's why you get the Russell 2000 to skyrocket as the NDX is plummeting because those are long NASDAQ, shortq, short russell. You know pairs, if you will, being unwound, but those aren't. Like you know people head diving first, like you know, uh, head first into nose, dive head first into, like long the russell or something, that's all, that's position exiting and position unwinding. But now you're getting the russell to plummet and all that. And then you're getting the last two days.

Speaker 2: 6:58

Friday you have the Topics Index, the broad-based Topics Index, to now underperform the NASDAQ for the first time since this July 11th moment. And the Topics Index is a broad-based index with something like 1,600 stocks and it's cap's cap weighted. It's much more diverse, it's not as heavily skewed like the SPXs towards like five names. You saw that index getting crushed. And then you start seeing you know, like I forgot the Nikkei.

Speaker 2: 7:24

And then today you start seeing topics index futures circuit breaker. You have a JGB futures circuit breaker. You have JGB Futures Circuit Breaker. You have JGB Yields getting crushed. You have MUFG, mitsubishi UFJ Financial Group, the largest mega bank stock, which had been a huge outperformer which I'm long, by the way, or I was long getting absolutely crushed like down 20% today. And so you know, what you're seeing is nothing to do with fundamentals per se, but you're now hitting the point of like scrambling around and forcing of positions to unwind and you know having certain limit orders and you know levels just getting triggered, one after another, another deleveraging and all that. But it really does all stem back to just, you know, the shorting of the end carry trade being long, max peso being long USD, jpy, aud, jpy or whatever it is that often correlate with these other risk assets.

Speaker 1: 8:22

Right, it's a literal margin call mechanically. This was always the thing that I was arguing, and I always argued that that would be the spark for a credit event, because that does at some point translate to higher volatility, as we're seeing, and then higher volatility translates into credit spreads widening, which we're going to touch on too. But let's take a step back. Let's talk about what exactly the carry trade is. I am blown away and I'm very fortunate and I may say this with complete humility. I may say this with complete humility the number of people that have come out and said in my case, I was early on it, but I was ahead of everybody else, highlighting this as a risk. I'm very humbled by it, but I don't know if people really fully understand what the carry trade is, despite me explaining it. So, in your words, what is the carry trade? Why in the world does it matter?

Speaker 2: 9:06

So let me just say that the reason that I think that question in and of itself is a very particularly important question is because there is no singular definition of it. And I don't think that people realize that there is no singular definition of it. So we have to first start with the premise that there are many definitions of it. So when people say, like that's not the carry trade, there can all be the carry trade. So let's just first start there. So there isn't, like whatever I say, your definition, yeah, that too. That doesn't mean mine is wrong, that doesn't mean yours is wrong. There are multiple definitions. So people have to realize that there are different definitions.

Speaker 2: 9:40

Carry trade is the most basically in kind of this context is borrowing in a lower yielding currency, which is default. The yen, jpy rates are on the floor, even with this rate hike, and then you take those proceeds and then you invest in a higher yielding currency, which is basically anything else relative to the yen and JPY rates, and then you capture that kind of the yield spread, the yield differential, and that's essentially what the carry trade is. But then I've also given this example like how it comes in various different forms. I mean they could be. Carry trades can be something like very conservative strategies for people who are just taking like kind of you know, nightly income so long as the yield spread remains intact and they get credited to their accounts or they get debited, you know, depending on that yield spread and all that. But it's just like a long-term sort of thing that you just it's almost like a like a, like a uh buying treasuries and leaving it buy and hold until maturity, like long dated, and just get you know kind of uh coupons, like paid. It's supposed to be like that kind of sense. It can be anything from that to highly, highly levered, um, and just like half percent move, or, let's say, a five percent move in USDJPY, which is what the interventions do is wipe out in five handle increments at a time can wipe out a five percent nominal yield spread between USDJPY.

Speaker 2: 11:03

And then an example I give, though, is that people don't realize that Warren Buffett has essentially a JPY carry trade as well, in which so warren buffett is famously invested in like five of these japanese trading houses, and those are like very complex mega conglomerates that are in so many different areas and sectors and and things like that that it's almost impossible to do bottom-up like research on. They have, like you know, a thousand subsidiaries. You know ranging the spectrum of like convenience stores to interest in various other countries, but by and large, they're seen as like commodity plays. They rise and fall with commodity prices for the most part. And so what he did was like yeah, he upped his stake in um famously in april or march or april of 2023, which kicked off the nikkei upside, but he's opened that position the equal weight, five of the largest Japan trading houses in like August of 2020.

Speaker 2: 12:32

And when he did that, he issued Berkshire Hathaway issued yen denominated bonds at very low, if not like you know, like kind of sub 1% coupon, and he used that those proceeds to fund his long trading house positions. So what he did was I say it's a very brilliant macro trade he went in August 2020, warren Buffett went short bonds, long commodities, before commodities and interest rates skyrocketed. But in that sense, that's a carry trade that he has on as well. So that could also be defined as a carry trade too. So, to answer your question, all of those and then more is what a carry trade is.

Speaker 1: 13:18

So, similarly to there's a lot of definitions, there's a lot of different ways of calculating it right. So there's a question here from Justin on X how big is the carry trade? I think the BOJ has a balance sheet of $5 trillion Japanese bank runs. Now I've seen figures that say $20 trillion. Lynn Alden actually sent me a DM saying that number doesn't make sense to her given the way money supply growth works. But it's still a big number regardless, and she and I went back and forth as far as what that could look like. But do we have any sense of how much leverage the boj? Yeah, well.

Speaker 2: 13:48

So that's another thing too, because everyone has a different definition and because a lot of it is especially in the institutional side is done, you know um, not off balance sheet per se, but it's not done in a sort of you know uh, exchange, you know lit market, if you will. It's done very much OTC, and so it really is impossible to like again, like you could argue about that all you want to, but it's just, it's not possible to calculate period. So let's see, I have something about that though it was from, I think it was like MUFG Research. Basically, they basically have JPY liabilities as foreign currency in USD. So the carry trade is the highest level since leading into the 2008 financial crisis currently, and it has shot up significantly, kind of broken out and shot up significantly in 2020, since 2022 yeah, 2022 really, when JPY started to melt down.

Speaker 1: 14:50

And, by the way, there's a lot of interesting research around how the carry trade was one of the reasons that 2008 happened the way it happened. I mean, I don't know if people really understand that point.

Speaker 2: 15:02

Yeah, yeah, so the RBA, the Reserve Bank of Australia, printed a research report you guys can look it up about. People really understand that point. Yeah, yeah, that that was, um, that was. So the rba, the reserve bank of australia printed a research report, um, you guys can look it up uh, about japanese retail investors.

Speaker 2: 15:11

Retail investors who had engaged in the carry trade leading up to 2008 which basically trickled into, you know, the, the selling of yen, and really aud, jpy was the carry trade of choice. Um, I think that there was maybe like a four and a half percent like nominal yield spread differential between Aussie rates and JPY rates and that the ballooning of that had essentially kind of indirectly or maybe even directly helped fund the long subprime mortgage, like instruments that then blew up, and so it was like, if I think it was June or July of 2008. So in between Bear Stearns and Lehman Meltdown, you saw like a face ripping short cover of the carry trade and you see AUD plummet like I don't know, like by almost by half within, like you know, three months or so. So it's insane, so that's a problem. Then jpy obviously, you know, uh, skyrocketing and that was a massive carry trade unwind. Um, but I think after after july 2008. I think things were fine in markets after that, if I remember correctly.

Speaker 1: 16:17

Oh no, no, they weren't at all yeah, my memory is a little fuzzy on what happened and the lagged effects. It's like this has been the other thing which I've kept on stressing. I even put that post out earlier. It's still on Instagram. I said the lagged effects will hit when everybody thinks they never will. Right, and we got to that point even just. I think anecdotally I can say that from the financial advisors I've talked to the last several months here and individual investors.

Speaker 1: 16:42

I shared this post. I want to get your thoughts on this, because the comment now I'm seeing a lot on X is they're going to print money. Here comes the burr. It's coming back, okay. So I put this post out. Here comes the burr, the printing of all the more just in response to this. So I put this post out. I want to get your response to this. I said they can't print their way out of this one. This is about a rate hike cycle mismatch with Japan. They'll worsen the dynamic by cutting rates because then the interest rate differential narrows. If that narrows, that should put more upward pressure on the yen. I mean, am I off on that? That the solution isn't as simple.

Speaker 2: 17:17

No, that's not really up for debate, that's pure fact. That's what's happening. You have a monetary policy mismatch, directional mismatch. You know that's what you're saying. Right, the fed yes, the fed is done ripping every, not the fed. The world x japan is done, ripping rates higher um. And some are cutting the bank of england. Just cut um. And the fed. So who cares if they do it in september or if they just signal it in July or if they do two? And if they do like this, who really cares?

Speaker 2: 17:48

The general direction is most likely Fed funds rates aren't going to rip another 5 percent higher. Probably not, and more likely they will either flatten out and or fall. Either flatten out and or fall um. So that directional reversal would sort of help the yen, because that was um a big part of why the yen got destroyed versus usd in the first place, starting in 2022, when they started ripping rates higher and boj was steadfast and keeping yield curve control and stuff like that just, you know, maintained no matter what, unconditionally, almost um. So now you have that happening and at the same time you have the Bank of Japan, I guess on a hiking cycle as far as that's a find in Japan. But yeah, you have once again a continued difference in interest rate policy. Just, the polarity has now flipped.

Speaker 1: 18:43

Yeah, so key to my thesis. In August, when I first really brought this up, I said the issue is not so much the yen, the issue is oil priced in yen, because oil is denominated in dollars and as oil rises and the yen weakens, for a country that has to import all of its energy, that becomes a real problem from a cost push inflation standpoint. And now you've got the specter of war again. Who knows three, four, I don't know what world war we're on now anymore between Iran and Israel. But how does the movement of oil impact anything as it relates to this? Or is this just underway? We can't really kind of expect anything to throw it off.

Speaker 2: 19:24

So in the near term as in the immediate term. By the way, let's clarify for everyone, as far as also for ourselves too, we're on different time horizons too. I just opened shorts on Nikkei futures and DX futures last week. This morning, before this, I was scrambling to trim some of those USDJ Yen futures position, stuff like that. I'm also long MUFG and took a fucking, like you know, 40% hit in the last two days. After that wiped out the year to take gains in two days. So my time horizon is very short as opposed, you know, relative to yours. You also have a very different role as ETF vendor. You also have a very different role, um, as etf vendor.

Speaker 2: 20:11

Um, so oil prices in the immediate term, like I wouldn't. I would say just general, generally speaking, um, oil prices or otherwise, I wouldn't look, read too deeply into like current shorter term intraday market movements as what the collective markets are telling us is happening and like extrapolate some giant recession thesis or something like that. Like you're applying short-term, shorter term market green and red blinking ticker, um behaviors and movements that are often tied to like forced position exiting, unwinding, that sometimes are triggered by others uh, you know, you know other other markets or other tickers that have nothing to do with having to liquidate that position, except for the fact that it's owned by the same manager who has to liquidate things. So I wouldn't extrapolate too much. But in the outside of the shorter term trading world that I personally would live in, yeah, oil prices are a key driver. So, markets-wise, oil prices probably are the key driver of JPY from a markets perspective, just because you know commodities markets, just because of the fact that Japan has to import so much oil which is priced in USD, oil or energy subsidies coming in Japan and all that. That's why the bank of Japan had just released their outlook report to the quarterly outlook report, in which they revised down CPI because of energy subsidies that are coming, but then therefore they had to revise up the next year's year on year. You know base effects but yeah, there there is sometimes invisible in charts, like clear you know oil versus USD JPY alignment, that alignment that occurs. So yeah, when you have like Middle East conflict and stuff like that, that's not good for the Japanese.

Speaker 2: 21:57

You know on the ground person and speaking of that too, and kind of outside of markets. I think it was Lynn Alden who recently kind of asked about are people in japan like actually paying attention to, like the actual jpy rate itself? And I think that that's that's not a stupid question at all. That's a fair question, because people why would they otherwise? Right? But my answer to her was yeah, absolutely, they are like that is, like this is front page news, like the rate itself, um, and people who never used to pay attention to it, they, they know that, like the yen, is the yen getting destroyed environment andgetting-destroyed environment and that's a bad thing, not a good thing, good for exporters, whatever, no, no, no, this is a very, very bad thing.

Speaker 2: 22:35

And they also know that they're paying a lot more for especially energy-related costs, and to the point where nursing homes are going around room by room every hour to make sure that people aren't trying to tough it out by not having their ACs on and stuff like that. And the Japanese regular people are trying to figure out what other personal expenses to have to cut, because air conditioning and all that is an inevitable rising cost that they have to live with. So, yeah, so they know that there's something about, even if they don't know the mechanics. They just know that there's something about like weakening yen and the prices that they have to pay for energy costs. Those are somehow linked and they're very pissed off about it. And then that feeds into, by the way, politics, which is what feeds into what we saw in this latest interest rate policy, this shock rate hike out of the Bank of Japan this past week. So, yeah, that's a huge part of it.

Speaker 1: 23:37

And there was and I believe it still is, a tremendous amount of short speculative positioning against the yen, which is not just the carrier trade, but just people were shorting the yen to make money, right, so everyone was so one sided on this. I've made this point before. The risk is that you get this uncontrollable short squeeze. Now the yen's been moving pretty aggressively, obviously, especially today. Let's talk about some points where, from your perspective as a trader, you'd say OK, now it might be enough. What level for the yen are you talking about when you say OK?

Speaker 1: 24:06

I actually want to buy into this as far as the equity side, the risk-on side. Okay, Well if you want to share your experience, you've got some chart to show.

Speaker 2: 24:16

yeah, yeah, so here's what. So, yeah, you know that chart that I had tweeted out a chart earlier about of the of NDX futures, nikkei futures futures and jpy um, very highly correlated also of nvidia as well, because I know that you love that stock so much and um and the character as well.

Speaker 1: 24:37

Please, please, tell everybody that I'm not crazy, that part of the oh, that's sarcasm nvidia. Come on, man, it's like it's the poster child for the carrier trade. I don't know why people don't see is the correlation is is clear, the causation is there.

Speaker 2: 24:51

Well, yeah, so let me just tell you Okay. So there's something called NISA accounts, n-i-s-a. If you don't know what that is, and if you're an equity, if you're a US equity investor and you don't know what Japan NISA is, you need to know what that is Okay. Is you need to know what that is okay nisa is? It stands for nippon investment saving, savings, whatever the hell it stands for. The uk has a similar scheme and where you basically get to invest um tax-free up to a certain amount. That got revamped in. That existed for a while, but that got revamped in january 2024 and since then there have been an enormous amount of new NISA accounts being opened and new assets flooding into those NISA accounts that are investing in USD stocks, s&p 500, nasdaq 100, and a single single stock which always makes that kind of top 10 list, and that is ticker NVDA.

Speaker 2: 25:44

Okay, now why are they doing that? The Japanese aren't buying US equities because of American exceptionalism or whatever the hell. They're fleeing. The yen is what they're doing. The yen is, or cash holdings are, more than 50% of Japan, household assets of financial assets, more than 50%. So relative, if you want kind of a context. I think the US is about 15%.

Speaker 2: 26:12

Japan is a massive cash hoarding, cash saving society. That's what 30 years of deflation is. That's literally mattress cash or stuffed in drawers and things like that. And why are they doing that? Because it's a very risk-averse culture. The kind of thinking is that because Japan's government has so much outstanding debt, the Japanese government will not be there for you. This is what NISA is basically admitting. The government is basically openly saying the government is not going to be there for you to fulfill its social security, all that kind of obligations that you paid into. You are on your own. You must build financial assets, you must build your cushion, and it's like a $200,000 USD sort of cushion for retirement is the figure that's been thrown around. So people will just save cash and that's great.

Speaker 2: 27:05

In a deflationary environment, prices don't go up. People don't even think about this concept of purchasing power. Why should they? Well, that's fine. But then, when you have inflation happening and you have the JPY getting destroyed, then that safe haven the supposed safe haven your 55% of household net worth is now a concentrated long JPY position. Household net worth in is now a concentrated long jpy position. So you went from being like in the safe haven to now like a concentrated long, like the worst performing currency for three years running now.

Speaker 2: 27:38

So people are starting to realize that and there's that is probably the most significant thing is that like, yeah, there are short sellers and speculators and all that who have record size yen short positions on, although those are being pared back and, you know, closed out. But the biggest sort of fear, I guess, um, or the biggest concern I have, and certainly probably the government, although never acknowledges is capital flight out of japan. If, because that's not closing of like short positions, that is, exiting of a natural long or a holding right, and if it goes, if it's coming out of japan. Japan is barely invested, uh, as it is, like the japanese household as it is, they're, they're in single digit percentage of stocks, but they have flooded into nasdaq stocks um from year to date to record levels, so much so that it like that that amount exceeds, like the country's sort of balance of payments um figure. In and of itself, okay, it's an enormous amount.

Speaker 2: 28:37

So if you're wondering why the united states stock market and the nasdaq has been like skyrocketing um or like is up so much against all these very, you know, legitimate bear cases or or reasons to be skeptical.

Speaker 2: 28:49

It's because of foreign flows, mostly out of Japan, that are doing this, and they're not buying US stocks and Nvidia and stuff like that. They're not doing that because of US-related reasons even. They're doing it because the yen is melting down and they're just looking for any non-JPY denominated asset, but because the NISA accounts only allow for equities and they don't want to touch the Nikkei index, which is much less sexy and it's at its all-time bubble peaks. The grass is always greener on the SPX side, is what I always say about the Japanese mentality. And so why not? Why not buy NDX? The NASDAQ stocks are these sexy stocks that they use themselves Facebook and Meta and Google, amazon, all that. So they invest in those and that's why they just continue to go up and up and up and up. And then another point I'll say to you, michael, sorry to continue on rambling like this.

Speaker 1: 30:13

I love this. First of all, you're educating me on things, which I appreciate, but it's like you're validating I'm not crazy and it's like I was clearly wrong in NVIDIA. But why was I wrong about NVIDIA? I didn't expect the carriage rate to last as long as it did, but now it's starting to slowly. Then, all of a sudden matter.

Speaker 2: 30:29

So this concept of people need to also understand that markets, equity markets well, actually global cross-asset markets that have like liquid futures, but especially equity markets, are very, very systematically driven these days Systematic funds and flows. In other words, they're not human beings.

Speaker 1: 31:00

Human beings are not the predominant, you know daily active market participants? Oh, you're telling me that? It's not the anonymous troll accounts with a hundred thousand bots that are following them, tweeting charts and putting squiggles from their basements while their pet hamsters are sleeping? You're telling me it's not those guys?

Speaker 2: 31:14

oh, I don't know about the pet hamsters part, but yeah, by and large, yeah, it's not those guys. Yeah, so like I think that look, and I don't know why people don't seem to kind of acknowledge this, but when you see very shallow market breadth in the United States, okay, what is that an indication of? It's an indication of a lack of activity of, you know, actual, like human stock picking, um, fundamental activity, like XYZ company, dcf analysis this is a great company in the S and P, like top 100 or whatever, and therefore let's buy shares and like the absence of that is what causes like very, very shallow market breadth. But then, in addition to that, look at like what happens during earnings season, which we're, I guess we're in the middle of, in in the us, when you see like double digit, you know, or 20 percent gaps up and down. You know, after earnings releases in the aftermarket or in the pre-market the next day off of like relatively in line, maybe a slight miss, maybe a slight beat, but like huge, you know, gaps.

Speaker 2: 32:19

What that is is that's like that's when you see the active human being, you know fundamentally based capital that is waiting for results, that gets the results, and they all jump in at the same time simultaneously and that's why you have these huge, huge swings on an intraday basis, like like I was. I wrote in my sub stack, like you know, is that really like? Is that how you know kind of free, free markets are, efficient markets, price things like systematically sort of driven markets and systematic and CTA flows and funds. Up until like the intervention moment of July 11th at 8.43 am Eastern Time, they were set to like short JPY long, ndx short, you know, russell 2000, all those sort of trends that were working out like fantastic, and then they just got blown up. So there is like that part of it, like the systematic part of it. It's not just like they're not all reflections of human beings and nor are they reflections of human beings opening new positions, new longs or anything like that.

Speaker 1: 33:40

A lot of it's just exiting, you know, like existing positions that people have to realize that that's also price action explanations. I will say real quick it is. I put out that post like two weeks ago I said they sucked everybody in with a small cap rotation narrative, just as the character traits about to reverse. I mean it's amazing how the market just did that. It pulled them in just before this happened. A thought came to me as you were talking about the NISA accounts and actually Alex Nova, who I haven't chatted with in a while but, alex, good to see that you're watching this put the Wikipedia link to learn about the NISA accounts With the opportunity set. Is the Russell 2000 even available for those investors or is it just large cap?

Speaker 2: 34:22

Because I wonder if that explains some of the differential also between large and small. Yeah, it's available doesn't mean that people are going to buy it. Yeah, right, um, you know so, the biggest. So they like there's various kind of um funds. A lot of them are these, like they're you can call them etfs, I guess they're, they're. They're more or less behave like etfs, um, but the, the funds that get the biggest inflows, like the top 10 of them are at the very top, is like this all country world fund, right, and it's supposed to be. I guess it's just a mix of dm equities, that is, 60 like microsoft and uh, like the top tech stocks.

Speaker 2: 34:53

Okay, so that in itself is that the rest of them are from, like you know, number two to ten are like sb500, nasdaq, 100 sort of targeted um uh funds and some, and then sometimes here and there actually I haven't checked recently you do get like an india fund, because india is also kind of a. That's like the non-us sort of em play out of japan because japan doesn't want to invest in china. Uh, neither does the rest of the world, neither does china itself. Um and um, you know so. So you get that every now and then um, but then, like I said, every now and then you do see a single stock ticker that shows up and that's NVDA. So that's what they do. And do you think that these people are diving into earnings and guidance and listening? They don't know what Jensen Wang is saying.

Speaker 1: 35:49

And the best picture of people on X and social media aren't either. It's not fundamentally driven, it's leverage-driven. It always is leverage-driven. That's what FOMO is about. Fear of missing out is what creates the desire for leverage.

Speaker 2: 36:04

Fear of missing out. But the thing is, when it comes to NISA, it's not missing out, because Japan's used to being missing out.

Speaker 2: 36:11

There's no fear there, japan is so unique that it's happy to miss out, been happy to miss out for 30 years. That's why the Nikkei didn't break its record high from its bubble pop 30 years ago, until recently. So they're fine with missing out, hence sitting in cash. What they're not fine with, therefore, is that cash to start getting burned. And so now it's just not fear of missing out, it's fear of you know losing savings Of their savings exactly Getting decimated, and so it might sound nonsensical to therefore find safety in NVDA shares.

Speaker 2: 36:54

First of all, I don't give a fuck what you think. It is what it is. It's a cultural difference of mindset that you have to really understand via taking yourself out of your bubble context and putting yourself in the shoes of somebody else from a different part of the world, and you have to look at it from that perspective, like this whole concept of American exceptionalism right, which I believe in. I truly do believe in that because of American exceptionalism, american exceptionalism means that the rest of the world is therefore going to be flooding into and investing into this exceptionalism that is America. Ok, I don't understand why American exceptionalism equals, america, only invests in America. American exceptionalism equals America only invests in America.

Speaker 2: 37:35

Like there are factors that, because of these global you know flows into USD, us Treasuries, us stock markets, you have to therefore pay attention to what's happening in other parts of the world, because something there can cause a pull out or a rush into this exceptional America, and that has nothing, that may have absolutely nothing to do with America in and of itself. So you know there's, there is like that, that part too. So just to add on to what you were saying about people who are kind of wearing blinders. There's also like a lack of people who are not acknowledging that, like, the S&P 500 is not an American or US asset, it's a global asset class. So are Euro's treasuries, so is the US dollar.

Speaker 1: 38:24

Do you get a sense that the Bank of Japan is bluffing in terms of getting hawkish, and I'll tell you why I frame it that way. So I put a piece on a sub-stack my own sub-stack on the Lager Report from May 10, where the argument that's being made is that you can't really raise rates in Japan because of the mortgage rate dynamic and housing, which also gets decimated with any sort of hiking cycle. I mean, how much more can the Bank of Japan do anyway, and do they even need to if the yen is going through this short squeeze?

Speaker 2: 38:54

going through this short squeeze Do I think they're bluffing. So what you mean by that is are they going to hike anymore after this shock hike? Yeah, okay, first can we just acknowledge that the Bank of Japan last week okay, I think again this is going to go back to the American exceptionalism point. Okay, the least market consequential for this current moment central bank that had their policy release is the fucking Fed, the FOMC, and they're doing over the nothing and the promising of a rate hike in September. What's more important after that, the Bank of England, who actually did cut rates, and that was kind of england who actually did cut rates and that was kind of like a 50 50, like you know, markets didn't really know which way, but arguably you could either say the fed doing nothing and signaling that they're going to do something in start, caught in september, which is something that's been long priced in and expected and speculated about for like over a year now, or maybe is it that the bank of japan shock lifted rates basically off the zero bound, um, like within, via press leaks from 12 hours earlier, and then actually executing it and then remaining hawkish like governor wader remaining hawkish, uh, after that I think that might be kind of a much significant, relatively speaking. Ok. So your question of are they going to maintain this Right? No-transcript? Doing that they had they helped they hold these like bond market group, like investor survey groups, like basically bond market participants, uh, jgb market participants, and they would get feedback from them and essentially, um, they designed the policy around that. So when they released how they were going to trim the pace, that they were going to trim jgb holdings and all that kind of thing, which was basically going to be about 400 billion yen per quarter down to three trillion yen, so basically half of what it currently is on a monthly basis, by the end of was it fiscal year 2025 or something like that? Okay, so that was not only just priced in already, but that was dictated more, not dictated, but that was already like that was guided by via bond market investors themselves. So there's no surprise there and there's no surprise that there's no surprise there.

Speaker 2: 41:47

So the if the bank, japan, who's so kind of focused right now, is clearly the yen. Everybody knows this, they know that, everybody knows this and they are, for the first time, acknowledging, at least publicly, that, yeah, the yen is a factor. You don't have that lever of the QT-ing or the lessening of QE, of JGB purchases, to hit markets on BOJ Day anymore. So you have that. So you have like a kind of a hike, a sort of shock hike, and and it's not just a hike, by the way, and I know it's only 15 basis points, I don't know, it's only to 0.25 to a quarter, you know a quarter percent or 25 basis points. The reason that's significant is because, michael, I'm sure you remember, but do you remember, leading up to the first rate hike off of zero under janet yellen in de, whatever, 2015,? Right, how much like not just guidance from the Fed, but like the fanfare around and like, oh my God, it's FOMC day, it's lift off of zero day, and like, and it was understandable because, you know, after the financial crisis, rates were like collapsed down to the floor Fed funds rates and they were left there for a very long time. So who knows what's going to happen once that kind of lifts up? And then they lifted the rates and then everyone kind of looked around and was like, did the world blow up? And everything was fine. So in retrospect it looks a little bit overdone, right, but still I think that some of that caution was warranted. Well, the Bank of Japan just basically lifted off zero like in a shock manner. Japan Japan did as everyone else, as you were saying, is on the verge of like cutting, so that's kind of an insane thing. So why do they do that? Okay, they'll say that this was Ueda will say that this was a necessary thing, because a necessary thing because of you know, we need to get ahead of things like currency dynamics or, like you know, risks of inflation or whatever it may be.

Speaker 2: 43:33

But he'll say that, like it's better to be ahead of it than to wait too long. And then, you know, rip rates higher, or something like that. And then he's also saying, though, like he remained very hawkish and I don't I don't think that necessarily it's a matter of bluffing or not because he remained very hawkish, like people thought, okay, so they shock, lifted rates, but then at the conference he's going to just tone it down and give a dove. It'll be a net, net dovish rate hike. It was not a dovish rate hike.

Speaker 2: 43:58

He was saying like, by the way, like you know, because somebody asked him, what about this 50 basis point ceiling? Right, because that's that's kind of this perception that there's a 50 basis point ceiling for boj rate hikes, and he's like there's no such 50 basis point ceiling. So he kind of dispelled that now. Whether or whether or not that's true we'll see, find out real time. But he did explicitly say no 50 basis point ceiling. And furthermore, he's saying, like, as long as, like the economy and like the data performs in line with the outlook right, not exceeding the outlook, in line with the outlook, we will continue to raise interest rates.

Speaker 2: 44:30

Okay, so that could be, I don't know up to 1%, 1.5% on the BOJ policy rate, for which they've just now brought up to 25 basis points. So now they can move in a normalized 25 basis point increment at a time. So if you say, like what? 25 basis points every three months or so, you know you can get to like a 1%, you know, within a year's time. That seems to be like what they're kind of laying out, and I think that it's not.

Speaker 2: 44:57

The you know the end had already been crushed down 10 handles at that point, so it's not necessarily, at least perception, wise for the end. I think that they are really trying to do that. I could also argue too, though, however, that because the yen got crushed down, that's why they were able to do it? Because if they're doing it with the end that, because the yen got crushed down, that's why they were able to do it. Because if they're doing it with yen pressed up at 1.62, then it'll be like oh, now you're actually using monetary policy to affect currency rates, now that it's off of that, but it's still very, very high USDJPY. That's why they could, you know. So there's a bunch of ways to do that, but I don't think that they're bluffing per se, but I don't think it's a bluff or not. I think that they've actually truly lost their whatever shred of independence that they had left at this meeting.

Speaker 1: 45:43

The counter that I often see is Japan wants inflation, so why would they try to squash it now? Let's talk about that, because that is the thing. It's like they've wanted inflation and now they're starting to hike rates and it's like, all right, well, you're going to hike rates, you're going to stop the inflation.

Speaker 2: 46:00

Right, but Japan's inflation is externally imported inflation by way of like, I said, energy and the yen. So the Bank of Japan is in the business of like, of not currency management, but certainly currency considerations. And the thing is that if Japan Okay, so if Japan is like oh sorry, I'm getting market notifications like crazy If Japan is raising their rates and all that, and they're doing it because of inflation, as they say, it's nonsense, because take Yield Curve Control, for example. Yield Curve Control had existed since September of 2016. And so when the Bank of Japan shock lifted yield curve control bans under Governor Kuroda in December of 2022, people were saying, oh, that's the Bank of Japan finally reacting to CPI raising above target of 2% in Japan. And so therefore, now that inflation has finally reached Japan, yield curve control is being unwound and all that kind of thing.

Speaker 2: 47:14

Yield curve control had nothing to do with japan's inflation, like it was in place for years, over a decade. Before that. There was no inflation that was generated of japan as a result of that. Japan inflation was a result of global inflation that was occurring not because of yield curve control. So what the hell would the removing of yield curve control caps, or like the raising of them. What the hell would that have to do, have any impact on the mitigating of inflation that it didn't cause in the first place? And I would say the same thing about, like you know, about the short term policy rate. There is the mortgage thing with floating rate mortgages and all that because they reset every five years that in that time frame.

Speaker 2: 48:00

Essentially what he's saying is that in that time frame the policy mix will outweigh the growth in real wages and all that will offset any sort of increased mortgage expenses and all that. So he basically not brushed it off, but he acknowledged it, but with a kind of a very nonsense answer. And yeah, so that's where that stands. But yeah, inflation in Japan is not. It is kind of a zero sum from the Japanese perspective, like because if energy inflation is occurring, you're going to spend less on other things and you're going to choose to, not because you have to, but because things are going up. People are not chasing prices higher because things are going up. People are going to save more because prices are going up. That's how it works in Japan. Mentality wise.

Speaker 1: 48:52

I love this point, which is obviously very accurate. Japan's debt to GDP ratio is like 280 percent. Won't rate hikes? Blow them up.

Speaker 2: 49:02

No no.

Speaker 1: 49:04

Yes and no. The government owns their own bonds right.

Speaker 2: 49:08

What does blow them up mean? And no, they won't, because why would they blow that on themselves? Because they own, yeah, cause they've cornered the JGB market. And if they do, they're going to blow it up on the, the, mostly on that which owns JGBs, which is mostly the bank of Japan. But at the same time, you're starting to see like kind of relatively speaking, fiscal, like prudence I'm very hesitant to say that out of Japan, but relative to how they have been before, they are starting to acknowledge higher interest rates means the cost of issuing JGBs has gone up four or five-fold within the space of a year, and all that JGBs has gone up like four or five fold within the space of a year, and all that. And they're trying to they they always try to aim for, like you know, balancing the budget and all that kind of thing. But I think that, as it relates to government debt, currently the Bank of Japan is trying to unwind or to lessen the amount of JGB holdings that they have, and it actually it sounds like a lot Right when you say like OK, they're currently buying about 600 billion yen, 600, 600, sorry, 6 trillion yen worth of JGBs per month, and they're going to try to bring that down to 3 trillion yen in a very laid out, specific manner within, you know, in a gradual and predictable manner within the next like year or so. And so that's a minus 50%, you know, drop. That sounds like a lot, but what that means is that that's lower. That's like something like a six or minus six minus 7% less of JGB holdings on the balance sheet is all it is. So it might sound like a drastic measure, but the Bank of Japan is still the player, the necessary player, and creditor to Japan, and so I don't think it's going to blow anything up in terms of Japan default or anything like that, because they could control both levers the fiscal, the issuing as well as the buying of JGBs, as well as a setting of where the JGB yields could be via these fixed rate operations where they're bid for unlimited at yield level X, which they got rid of, but they could always reintroduce, as they say in their latest meeting.

Speaker 2: 51:35

No, I think that what I always say is Japan is sustainable. No, it's not sustainable. Is it more sustainable than we think? This supporting of the JGB and JPY markets simultaneously Is that sustainable? No, is it more sustainable than we think? Yeah, it can go on longer than we think and that's why they are widow makers. That's why there's a widow maker trade Because it's not sustainable. People put that trade on Because the Bank of Japan and the Ministry of Finance can carry this on for longer than people's time horizon. That's why they get blown up. So that's the answer. If you're asking from a trading perspective, is there going to be a blow up? No, your portfolio is going to blow up. Is there going to in the longer term? Like history textbook sort of context, yeah, you'll. This is not sustainable.

Speaker 1: 52:29

So we only got about 10 minutes. But speaking about timeframes and being a trader, I am curious to hear your thoughts on, at least very short term, how you think this plays out. I myself have said to a lot of people's surprises, I think that given the fact that everybody seemingly now is on this reverse carry trade, my contrarian intent is to go up. I even put out I was looking at my analytics on X right and I had my second biggest impression day like 5.3 million impressions in a single day as everyone started realizing the reverse carry trade may actually be here. The last time I had something that high was when I was peak bearish at the end of October and Black Monday was trending and that entering November ended up being the low.

Speaker 1: 53:07

So let's do a little bit of a contrarian thought process here. Short term right. Short term. Short term right Short term. Is there a chance that everyone now is so bearish suddenly that maybe we have some kind of a rip before what I'm saying, a bigger main event comes and I'm just talking like maybe for like a week, not like some multi-month period.

Speaker 2: 53:26

Well, what do you mean by bigger main event Meaning?

Speaker 1: 53:36

Like, look at Japan. Like you know, global markets right now it seems like a pretty big main event. But I guess where I'm going with that, where the S&P, for example, would round trip and give back all the gains for the year as an example.

Speaker 2: 53:48

Yeah, potentially.

Speaker 1: 53:49

Could you see it move higher?

Speaker 2: 53:50

first, before that, well, I would say so I don't know levels-wise, but I would I think that. So, again, in the context of, like just japan, um and or, like you know, flows, flows into the spx via, like these nisa accounts and all that, so the the topics index and like, if you're getting 99% of the Topics Index names getting sold off indiscriminately and down to official correction territory, then to bear market territory within two days, and all that kind of stuff, the Japan investors are invested, of course, in Japan equities, but