This week began with a bang, marked by historic market movements in Japan that have further accelerated the ongoing unwind of carry trades in the yen. Overnight, the Nikkei 225 index experienced its worst day since 1987, wiping out all the gains accumulated for the year and dipping to levels not seen since November 2023.

Factors Driving the Turbulence

Several key factors have contributed to this volatility. A hawkish rate hike from the Bank of Japan, weak U.S. payroll data, and escalating geopolitical tensions are all playing a role. However, the primary catalyst appears to be the unwinding of popular trades, particularly in U.S. tech and artificial intelligence stocks, carry trades, and short volatility positions, which have been unwinding one after another.

In the forex market, this has manifested in a sharp drop in the USD/JPY pair, which briefly fell below the 142 mark. This marks a staggering decline of nearly 20 big figures from a recent high of 161 in less than a month.

Market Sentiment and the Broader Context

Despite these significant moves, the market hasn’t reached full panic mode. A true panic scenario would typically involve a broad-based outperformance of the USD, which hasn’t been the case. While the yen and Swiss franc have seen notable activity, other currency pairs have remained relatively stable compared to the dramatic shifts in equities and bonds.

Recent economic data has been mixed. While the latest Non-Farm Payroll (NFP) report stoked fears of a potential recession, the ISM services PMI print offered a glimmer of hope, suggesting that these concerns may be overblown.

A Glimpse of Hope for a Reversal

Looking ahead, there is potential for a “Turnaround Tuesday” in equities after a sharp decline of nearly 6% since last Thursday. This recovery in stocks could pave the way for a modest reversal in the yen and Swiss franc as well. Historical data supports this potential recovery: since 2020, the S&P 500 has seen a cumulative return of 10.8% following declines on Thursday, Friday, and Monday, with an average return of 0.5% and a 63% hit rate.

For traders of USD/JPY, U.S. Treasury yields continue to play a critical role. With the 10-year yield bouncing back 10 basis points to 3.8%, there is room for a modest rebound in the currency pair. As always, keeping a close eye on economic data and market sentiment will be key for navigating these turbulent times.