We believe that though currently real economic conditions in US are not as weak as it is being reflected in US rates market pricing for cuts, we are soon entering a phase where financial markets might push the real economy into a real recession soon. Since it seems that only $ 0.2-0.3 TN size of carry trade has currently been unwound out of a total size of $ 0.5-1 TN globally, globally equities might face more turbulence. Then the financial market’s stress might get transferred to a slowing real economy & induce real recession. US consumers are heavily invested into US equities. As US equities fall more, US consumers might grow more cautious & spend less. And if the Fed responds to this economic weakness by cutting as markets are predicting now, USDJPY might appreciate more leading to more unwinding of carry trades leading to more pain for financial markets, more pain for US consumers via wealth effect and hence the loop becomes self-sustaining. That will be the real recession.
