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U.S. equity futures edged lower Thursday as markets around the world continued to whipsaw amid an historic surge in volatility tied to the unwinding of leveraged trades in Japan and concerns over the near-term fate of the world’s biggest economy.
The recent surge in volatility, which lifted the market’s benchmark VIX index to a four year high earlier this week amid the reversal of so-called ‘yen carry trades’ in markets around the world, hammered U.S. stocks again yesterday, pulling the S&P 500 into a late-session decline that reversed solid earlier gains.
A weaker-than-expected auction of $42 billion in 10-year Treasury bond yields, which drew muted foreign demand, also suggested that investors remain fixated on the yen trade unwinding and its impact on markets ranging from fixed income assets to global commodities.
The carry trade involves sophisticated investors borrowing money at near-zero rates in Japan, converting it to dollars and putting it to work for higher returns in markets elsewhere.
The market’s benchmark volatility gauge, while in retreat, is still pegged at the highest levels in more than two years.
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However, with the Bank of Japan signaling interest rate hikes, and the Federal Reserve poised to lower its borrowing costs over the coming months, the window of opportunity for that trade has been narrowed, resulting in a massive unwinding that has roiled global markets and wiped out more than $6 trillion in value over the past three weeks.
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JPMorgan analysts estimate most of the trades have been reversed, but suggest around a quarter of the positions remain in place.
That could be while VIX levels, although in retreat, remain near the highest in two years, with the gauge last marked at $28.47 in after-hours trading.
At that level, traders are expecting daily swings of around 1.787%, or 92 points, for the S&P 500 each day over the next thirty days, more than double the indication at this time last month.
The market’s secondary concern, that the U.S. economy is drifting into recession as a result of a weaken labor market, will also be in focus today with weekly jobless claims data expected at 8:30 am Eastern time.
Benchmark 2-year Treasury note yields were trading at 3.935% heading into the start of the New York session, around 5 basis points south of yesterday’s levels, while 10-year notes were marked at 3.912%.
The Treasury will also auction $25 billion in 30-year bonds later in the session.
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Stocks are looking to a cautions open ahead of that data release, with futures contracts tied to the S&P 500 priced for a 22 point opening bell decline and the Dow Jones Industrial Average called 155 points lower.
The tech-focused Nasdaq, which is now down 8.7% for the quarter, is priced for another 55 point decline.
In overseas markets, the regional Stoxx 600 benchmark was down 1.12% in Frankfurt, after posting solid earlier gains, while Britain’s FTSE 100 fell 1.05% after starting the London session firmly in the green.
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Overnight in Asia, Japan’s Nikkei 225 ended 0.74% lower on the session, while the yen strengthened to 146.09 against the U.S. dollar, suggesting more carry trade unwinding.
The region-wide MSCI ex-Japan benchmark, meanwhile, slipped 0.39% into the close of trading.
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