According to data from JPMorgan, three-quarters of global arbitrage trades have been closed, and recent selling has wiped out this year’s gains. Morgan Stanley’s quantitative strategists Antonin Delair, Meera Chandan, and Kunj Padh stated in a report that the return rates of the 10 country group, emerging markets, and global arbitrage trading baskets tracked by the bank have fallen by about 10% since May. This round of decline has wiped out the returns so far this year and significantly reduced the profits accumulated since the end of 2022.
Morgan Stanley’s quantitative strategist stated, “The spot portion of the global arbitrage trading basket indicates that 75% of arbitrage trades have been cancelled.” They reiterated that the time for arbitrage trades in the 10 country group is running out.
It is reported that global stock markets experienced Black Monday, and the lifting of yen arbitrage trading is considered the core reason for the market collapse. Arbitrage trading refers to investors borrowing currencies from countries with lower interest rates, such as Japan, to provide funds for purchasing high-yield assets elsewhere. Over the past week, global market volatility has intensified and arbitrage trading has been hit hard due to concerns about the Federal Reserve’s rapid interest rate cuts and the Bank of Japan’s interest rate hikes exceeding expectations.
The recent selling speed is twice the usual rate of decline in arbitrage trading, and strategists suggest that the chance of a rebound in August may be small because “the central bank’s schedule during this period is not much, and volatility has begun to cool down
However, they emphasized that the global arbitrage trading strategy “did not provide attractive risk return”. Since the high point in 2023, the yield of a basket of trades has dropped significantly, which is not enough to compensate for the risk of holding high beta assets in emerging markets during the US election period and further repricing low yield bonds when US yields decline
Technical pullback in US stock market
After several months of sustained gains, the strong rally of the US stock market seems to have come to an abrupt end in July: since the S&P 500 index hit a historic high on July 16th, the index has begun to oscillate and decline, falling for four consecutive weeks on the weekly candlestick chart, with a cumulative decline of over 8%. The cumulative decline of the Nasdaq 100 index is even more than 10%.
On Wednesday Eastern Time, Savita Subramanian, head of equity and quantitative strategy at Bank of America, reassured the market that the recent sharp sell-off in US stocks is just a “common technical adjustment” and is unlikely to turn into a comprehensive bear market, with no signs of the stock market peaking yet.
Behind the decline in the US stock market, there are multiple factors driving it: the explosive July non farm payroll report in the United States, the withdrawal from yen arbitrage trading, and increased market concerns about a US economic recession.
Sabramanian believes that the performance of the US stock market in the past few weeks is not a trend of the stock market plummeting after reaching its peak, but more likely a typical adjustment that occurs on average every year. He pointed out that from the history of the US stock market, market corrections are very common.
A pullback of over 5% is common, occurring on average more than three times a year since 1930 (this is the second time this year after April). Larger adjustments are less frequent, but still common, occurring on average once a year of over 10% (the most recent being in the fall of 2023), “Subramanian wrote in the report.
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