A bit of volatility

It would be hard to have missed the dramatic move in various asset classes over the last month or so. The Japanese yen fell to its lowest level against the US dollar since 1986, then rose over 10% in just four weeks. Nvidia, briefly the world’s largest company, fell 21% over the same period. The US government 10-year bond interest rate fell from 4.2% to 3.8%, before rising back to 4%. While that is only 0.4%, it’s a big move by bond market standards.

Markets absorb new information every day. And an investment manager is always looking to discern what are true ‘market signals’ from the vast amounts of ‘market noise’. The biggest periods of volatility usually come about when market participants believe that the current situation is going to change dramatically. Right now, this expectation of dramatic change exists across multiple asset classes - currencies, interest rates and equities.

What happened and why so fast?

In currency markets, Japan is raising its interest rates while most of the rest of the world is cutting or preparing to cut. One of the drivers of currencies is the interest rate difference between them – if an economy is strong enough to cope with high interest rates, it often sees its currency strengthen as investors seek out that attractive combination. But this interest rate rise had the effect of making the popular carry trade – borrowing cheap Japanese yen to invest in other markets’ growth assets – less profitable. Thes positions were quickly and dramatically unwound with the rise in interest rates announced by the Bank of Japan.