The classic notion of a carry trade is to borrow to buy securities whose yield is higher than the borrowing cost. In recent years, this has meant borrowing Japanese yen at extremely low rates, courtesy of the BoJ, swapping the yen in to dollars, and then buying bonds, often US treasuries, yielding much more. The idea is that not only will the rate differential pay well, but also the high-rate currency will tend to outperform the low-rate currency.

A synthetic version of this trade is to short yen futures and buy 10-year bond futures. The COT data shows that large speculators (hedge funds) have piled into this trade in recent weeks in huge quantity, to the extent that the commercials, taking the other side of the trade, have record short positions in the bonds and long positions in the yen. This looks like an accident waiting to happen fo the hedgies, because when the commercials’ position gets to an extreme, the trade usually goes their way.

Given the record size here, any accident could have significant knock-on effects. Watch the yen and the bond for sudden moves!