From "Trump trade" to "Japanese widow": Eight of the hottest strategies in the global financial markets right now.

This week, the unconventional geopolitical actions taken by US President Trump and the election strategies adopted by Japan have stimulated the rapid development of financial markets. Trump threatened to launch a new trade war against European allies because he demanded Denmark hand over control of Greenland to the US, but he quickly abandoned this stance. In Japan, despite the heavy debt burden and persistent inflation, Prime Minister Shinzo Abe promised tax cuts, which caused market turbulence. As a result, several high-profile transactions quickly brought either substantial returns or significant losses. Here are the histories, current status, and possible futures of some of the most popular market strategies: Basis trading This widely used hedge fund strategy, while historically occasionally losses occur, has attracted attention in recent years. The strategy involves borrowing funds (usually in the repo market), then buying and selling bonds, while establishing opposite positions in the futures market. The strategy aims to profit from the slight price differences between the two markets. Supporters argue that this strategy provides a crucial source of demand for government bonds as debt soars in developed markets. However, this trading carries extremely high risks. Due to the minimal price differences, investment firms must use significant leverage through borrowing to make it profitable. (It's like picking up coins in front of a slow-moving steamroller.) This leverage and reliance on short-term financing for trading occasionally raise concerns for policymakers and regulators. The exact size of basis trading is difficult to estimate, which lack of transparency itself causes concern for policymakers. In January this year, Morgan Stanley estimated that basis trading in the US has grown by about 75% since 2019, reaching around $1.5 trillion. Steepening bond yield curve trading As global government debt burdens continue to grow and the impact of recent central bank rate cuts gradually becomes apparent, future economic growth may accelerate (and potentially trigger inflation), causing anxiety in the long-term bond market. Additionally, in the US, concerns arise over whether the Federal Reserve can continue to maintain independence under Trump's leadership. These factors have prompted some investors to revisit the so-called "steepening bond yield curve trading" strategy, which profits when the yield curve slope rises. This may be due to the faster rise in long-term yields compared to short-term yields during periods of bond market weakness, or the smaller decrease in long-term yields compared to short-term yields during market rebounds. As fund managers withdraw from long-term bonds and these bonds are likely to be affected by fiscal and inflation risks in the coming years, short-term bonds have become a popular choice in the market. Meanwhile, rate cuts have supported the short-term bond market by lowering the yield on short-term bonds. This week, escalated geopolitical tensions continue to fuel this trade due to Trump's tough stance on US allies and growing concerns about Japan's fiscal situation. As companies like The Pacific Investment Management Company (PIMCO) begin to take profits, earlier debates on whether this trade lacks momentum have eased. The spread between German 2-year and 30-year bond yields widened to its highest level since 2019 on Wednesday, while the spread of US bond yields remains near its highest level in four years. In Japan, as the bond market faced a sell-off this week, the spread between 2-year and 30-year government bond yields hit its highest level since data has been recorded in 2006. On Thursday, after Trump withdrew his threat of tariffs on Europe, long-term bonds had some room to breathe, but fund managers including Allspring Global Investments and Fidelity International expect that given the fragile market sentiment, this respite may only be temporary. Arbitrage trading Arbitrage traders borrow in low-interest rate countries, sell their domestic currency, then reinvest the funds in countries with higher interest rates. Theoretically, exchange rates will adjust over time to reflect the interest rate differences. However, in practice, arbitrage strategies may persist for months, years, or even decades, coexisting with the overall imbalance of global capital flows. Arbitrage trading has flourished in large part due to the decline in currency volatility to multi-year lows last year. One indicator measuring this strategy shows that the return on an arbitrage trading strategy buying eight emerging market currencies against the dollar was around 18%. This is the highest level since 2009, mainly driven by strong spot rates and high interest rates in Latin American economies. Since arbitrage trading ultimately involves earning small interest income over time and loans must be repaid in the original currency sharp exchange rate fluctuations can quickly erase these profits. The significant market turmoil in Japan this week threatens the sustainability of a considerable portion of arbitrage trading. This is because, given Japan's long-standing negative interest rate environment, much of this investment is funded in yen, with the direction being investment in higher-yielding emerging markets. In 2024, as Japan raises interest rates, these positions are quickly unwound, causing investors to sell assets to repay loans, and the impact spreads globally. Given that Japanese government bond yields are currently near their highest levels since the late 1990s, and investors are cautious about official intervention supporting the yen, the effectiveness of this strategy may have decreased compared to last year. Joe Mazzola, Chief Trading and Derivatives Strategy Officer at Janus Henderson Investors, said on Wednesday that yen arbitrage trading "is coming back." Mazzola said, "Japan's policy rates and yields are at their highest levels in decades, and US risk assets are being impacted. The question is, how long will this situation last?" Currency depreciation trading This trading is suitable for investors who are concerned about continuously expanding government budget deficits and are moving away from sovereign debt and currencies to seek other means of storing value, such as precious metals. This is because these commodities are thought to be less affected by inflation caused by government policies and the modern financial system based on fiat currencies like the US dollar, euro, and yen. The rapid rise in gold prices since last year partly reflects this strategy. Major central banks (especially those of emerging market countries), asset management companies, pension funds, and other institutional investors have been buying gold to protect their wealth from the inflationary impact of loose monetary policies based on fiat currencies. During the Greenland incident this week, concerns about unpredictable consequences injected new momentum into trading, with precious metal prices reaching a historical high of $4,915 on Thursday. If investors continue to diversify their investments, reducing their allocation to US assets, gold is likely to continue benefiting from currency depreciation trading. "Sell the US" Over the past year, momentum for this trade has fluctuated. The volatility brought by Trump's policies is a key factor, as his rapid-fire statements and sharp departures from Biden's policies have created new risks, leading traders to reduce their investments in US assets. This sentiment was particularly strong in April: first, Trump announced his comprehensive tariff plan, then he threatened to fire Federal Reserve Chairman Powell. In both instances, the S&P 500 index suffered heavy losses, and US bond prices plummeted, questioning the safe-haven status of US assets. This week, as Trump intensified efforts to acquire Greenland and threatened US allies in Europe with new tariffs if they did not support his island acquisition plan, trade issues resurfaced. Tech stocks are often at the forefront of this. Tech stocks dominate the US stock market, and the so-called "Big Seven Tech Giants" have a significant impact on major indices, as the AI boom has greatly pushed up their market values. However, as the Greenland dispute has shown, the "sell the US" strategy often has minimal effects. Part of the reason is Trump's unpredictability, as traders widely believe he is likely to give up the most destructive proposals. This week was no exception, as the S&P 500 index fell by 2.1% on Tuesday, but regained most of its losses after Trump softened his stance on Greenland. 60/40 The popular 60/40 stock and bond investment portfolio, aimed at balancing the returns from stock gains and the protection provided by bonds in times of market weakness, faced pressure this week as stocks and bonds weakened simultaneously, with January at one point likely to be the first month of negative growth since April last year when Trump's "liberation day" tariffs shook the world markets. The index eventually rebounded, currently surpassing the average level for that month. Jack McIntyre, portfolio manager at Brandywine Global Investment Management, said, "The risk is that the economy data rebound significantly, and yields rise," signaling that the market no longer expects further rate cuts this year, which could lead to increased stock market volatility. Trump trades: TACO and Big Mac While some are "selling the US" due to Trump's policies, others are betting based on his remarks first, betting that he will not fulfill his promises, a strategy known as "TACO" (i.e., "Trump always chickens out") that has proven repeatedly successful. The first year of Trump's second term in office has shown a unique pattern: he threatens high tariffs on China, causing a stock market plunge; then he backs down, leading to a market rebound. For example, in October last year, Trump threatened to impose 100% tariffs on China, only to quickly retract. The impact of the tariff threat caused the US stock market to experience its worst day in six months, but after the president withdrew the threat, the market quickly soared. This week, after Trump softened his stance on Greenland, the stock market rebounded once again. People are concerned about this strategy. Some believe that if Trump's tough policies fail to create investor panic, leading to significant market volatility, he may not have the motivation to back down. Secondly, Trump-related trading strategies are based on the November midterm elections and his efforts to turn around low approval ratings before the election, known as the "Big Mac" trading strategy (i.e., "big midterm election battle on the horizon"). Ed Clissold, Chief US Strategist at Ned Davis Research, believes this will be a theme this year, with market focus shifting to policy plans announced around the time of the congressional elections. These actions have already started affecting the market. Under pressure to curb inflation, Trump recently called for credit card issuers to cap interest rates at 10%, leading to a sharp drop in some financial stocks. Trump also demanded defense contractors stop paying dividends and invest in production, sparking concerns about these companies in the market. Additionally, Trump's call for government intervention in the mortgage market to lower rates has cast a shadow over the prospects of Fannie Mae and Freddie Mac, causing a decline in the stock prices of these two companies. Widowmaker trade The term "widowmaker trade" refers to high-risk trading strategies in the financial investment field that are prone to significant losses. In Japan, this term has almost been specifically attributed to trading shorting Japanese government bonds over the past twenty years. The operation is simple: borrow and sell Japanese government bonds, anticipate a price drop, then buy back and profit from the difference. This approach has repeatedly led global investors to incur losses as the Bank of Japan has kept borrowing costs close to zero. Today, with the Japanese bond market undergoing one of its most dramatic repricings in recent years, this saying is being challenged. Several factors are driving the revitalization of this trade: the Bank of Japan's exit from yield curve control, reductions in bond purchase volumes, and Abe's efforts to reduce taxes. Market concerns that Japan's long-term borrowing needs will grow faster than expected have pushed super-long Japanese government bond yields to their highest levels in decades, causing global market volatility. Once synonymous with losses, the Widowmaker trade has suddenly become profitable although risks still exist. While inflation is no longer in the doldrums, the Bank of Japan is tightening monetary policy (albeit with limited intensity), and fiscal discipline is no longer as expected, current yields may be enough to attract domestic Japanese buyers back, limiting further increases. Traders say the uncertainty surrounding fiscal policy and the pace of interest rate hikes by the Bank of Japan may keep market volatility high. Overall, these various trading strategies and market dynamics show the intricate interplay of geopolitical events, monetary policies, and economic data that shape the financial markets and drive investor decisions. As these factors evolve, traders and investors will need to adapt to changing conditions to navigate the complex landscape of global finance.