Be cautious! The Bank for International Settlements warns that there still exists risks in the market similar to the unwinding of carry trades involving the Japanese yen.

The Bank for International Settlements warned that the financial system is at risk of experiencing another round of volatility, similar to when a popular hedge fund strategy collapsed this summer, affecting the entire market. In a report released on Monday, the Bank for International Settlements stated that as major central banks withdraw liquidity globally, investors will be forced to reduce leverage and review risk strategies. The so-called arbitrage trade unwinding is the latest example of the potential consequences of this shift. "We shouldn't have any illusions. This is not the first time, and it won't be the last time that markets experience turmoil," said Claudio Borio, Head of the Monetary and Economic Department at the Bank for International Settlements, at a press conference. "It's part of the bigger picture, inevitable symptoms of the transition from a period of extremely low interest rates and ample liquidity." Following the Bank of Japan's rate hike in July, traders who had borrowed large amounts in yen and invested cash in high-yield assets were forced to unwind their positions quickly. These intense fluctuations spilled over into other assets and raised concerns about leverage levels in the financial system, leading traders to speculate whether there will be more leverage in the market. The Bank for International Settlements stated that it is seeking to improve its tracking of arbitrage trades to better understand market vulnerabilities. Currently, information on forex derivatives, including forwards, swaps, and options, lacks clear explanations of each transaction's specific purpose. The Bank for International Settlements is working with its member central banks to gather more data on these transactions. One challenge is that investors often use forex derivatives for speculative arbitrage trading, as well as hedging and liquidity management purposes, making assessing overall activity difficult. In its report, the Bank for International Settlements noted that before the August meltdown, arbitrage trading strategies were very crowded and highly leveraged. The Bank for International Settlements stated that because the motives for participating in arbitrage trading strategies still exist, policymakers need to closely monitor developments. Hyun Song Shin, Economic Adviser and Head of Research at the Bank for International Settlements, said, "We need to keep a very close eye on the potential risks that are building up. The financial condition is crucial for the implementation of monetary policy, which is crucial for central banks."