Oil prices are Trump’s “big trouble,” while the yen is everyone’s problem

Two distinctly different risk threads are tightening simultaneously: oil prices are swinging wildly under political pressure, directly threatening Trump's prospects in the midterm elections; meanwhile, the structural shift in the yen could transmit shockwaves to every major asset class via carry trade unwinding, capital repatriation, and rising global yields.

After a sharp jump on Thursday, Brent crude plunged on Friday but remained close to $110/barrel, with only about seven and a half weeks left before the midterm elections. Since oil prices surged in August, the probability of Democrats regaining the Senate has risen from 41% to above 50%. Trump stated on Tuesday that oil prices would only fall significantly after the midterm elections—this statement may have reinforced market expectations of prolonged conflict but also increased attention on whether the White House will be forced to act to drive down oil prices. Meanwhile, the 10-year US Treasury yield is approaching 5%, further squeezing policy flexibility.

The directional shift in the yen is tugging on nerves across global markets. The US-Japan 10-year government bond spread has narrowed sharply over the past two years, while the dollar/yen exchange rate had lagged behind this change—this divergence is now being corrected. TS Lombard believes that Japanese capital repatriation is the main driver of the yen’s continued strength. Their fair value model points to a range of 130 to 140, meaning the yen still has significant room to appreciate. Once the yen “supertanker” accelerates its turn, large-scale carry trade unwinding could trigger a systemic rise in cross-asset volatility, making it hard for the VIX to remain at current low levels.

Oil Prices: Trump’s Political Arithmetic

Every rise in oil prices is eroding the Republican base. Since the sharp rise in oil prices in August, the implied market probability of Democrats regaining the Senate has exceeded 50%. Brent crude is nearing $110/barrel, and as there are only seven and a half weeks left until the midterms, the market is reassessing the GOP’s tolerance threshold for high oil prices.

Trump’s statement on Tuesday—that oil prices will only drop after the election—has to some extent strengthened expectations of ongoing geopolitical conflict, but that does not mean the White House will do nothing. Analysts believe that if oil prices remain comfortably above $100 before the election, combined with the 10-year Treasury yield approaching 5%, the combined political and economic pressures could force the White House to seek some form of relief. Should Democrats recapture both chambers of Congress, Trump’s remaining two years in office will be significantly constrained—a price that may be even harder to bear.

It is worth noting that the current volatility reflected by oil prices is far below the smaller spot price shock in July and much less than the violent swings in March. The volatility market seems to have priced in some degree of the price decline Trump needs.

Yen: Structural Shift, Not a Short-term Disturbance

The yen’s story is far more than a temporary exchange rate fluctuation.

Over the past two years, the US-Japan interest rate spread has narrowed sharply, yet the dollar/yen exchange rate barely budged—this divergence is now being swiftly corrected.

TS Lombard points out that the Bank of Japan’s faster tightening, increased political tolerance for yen strength, and a reversal of Japanese capital outflows are forming a combined force. Intervention might be the catalyst this time, but capital repatriation is likely the underlying driver that will sustain it.

TS Lombard’s fair value model indicates a reasonable dollar/yen range of 130 to 140, suggesting that even a drop below 150 may just be the beginning of this adjustment, and USD/JPY will face continued downward pressure.

Carry Trade Unwinding, Yen Volatility Threatens Global Assets

The yen’s issues are not limited to Japan—they are a hidden danger for global markets as well. The logic of carry trades is that volatility does not offset yield differentials, but as yen volatility (JPY vol) rises, the risk-adjusted returns for shorting the yen are deteriorating rapidly.

Official intervention acts as a catalyst, while rising volatility is the core driver that turns localized adjustments into broad-based unwinding. Shrinking leveraged positions are directly impacting global liquidity.

Capital repatriation to Japan Pushes Up US and European Bond Yields

The yen’s directional change is reshaping the supply-demand landscape for global bonds. According to Natixis, if GPIF (Government Pension Investment Fund of Japan) rotates funds into Japanese government bonds (JGBs), the impact will go far beyond the Tokyo market.

Historically, Japanese investors have been major buyers of foreign bonds. When they become more price-sensitive or start actively repatriating capital, this pulls a major source of demand just as global government bond issuance is accelerating. Thus, the yen’s shift could put additional upward pressure on US and European bond yields.

A Strong Yen Could Awaken the VIX and Trigger Global Risk Aversion

A strong yen not only reflects heightened global risk aversion—it can itself create this sentiment. A disorderly drop in USD/JPY could force a global carry trade deleveraging in risk assets, turning the yen’s rebound into a broader global volatility event.

With the VIX index recently reset, equity volatility currently provides a very attractive hedging tool for such tail risks. If the yen “supertanker” accelerates its turn, global volatility will no longer remain dormant.