Savage Unwind Of Carry Trade

Charts: The S&P 500 closed at 1097, down 1.2%. The broad index crashed through two support levels and the Nasdaq lost the key 2200 level in big volume. The rally is under extreme pressure but small caps actually dropped less than large caps so the recent improvement in leadership is intact. Financials were slammed hard and represent an ongoing problem technically.

Fundamentals: Weekly jobs data came in soft but the real cause of today’s sell-off was a savage unwinding of the dollar carry trade, the worst unwind that we’ve seen so far in the bull market and a continued response to the Fed’s seemingly innocuous statement that it still intends to end Quantitative Easing someday. Also, Greek sovereign debt is still getting hammered, which is hurting the carry trade. The carry trade is based on shorting the dollar and the problem with any short position is that traders are sometimes forced to cover shorts en masse in a so called short squeeze. A long position can only lose so much, only the initial investment and no more, but a short position can entail infinite losses, which can force short investors to hastily unwind as they stare into the abyss of total financial destruction. Nobody knows how big the carry trade is, how much leverage it commands, or how it will affect global financial markets if it totally collapses. On a positive note, if the carry trade does indeed dissipate we will be able to invest once again on fundamentals.

Geopolitics: Iran successfully tested a missile that can hit Israel. This caused oil to jump yesterday, a reminder of what the Long War is all about: black gold. Iran has been caught providing technology to Shiite rebels in Iraq that can track American drone flights. As we know Iran is also supporting Shiite rebels in Yemen as well as Hezbollah. There are two kinds of guerilla armies, those without state sponsorship and those with. The latter kind is much more difficult to defeat. So it is disquieting that Iran is supporting so many bad guys across the globe. Geopolitical news has been good overall but not so much as far as Iran is concerned.