by David Robertson, CFA
October 2025
The third quarter was a good one for stocks in which they spent a good chunk of the time hitting fresh new record highs. In addition, while the path of travel for bonds was less smooth, the general upward direction (yields downward) was similar.
Such benign outcomes resulted despite an increasing array of risks. Why do stocks keep storming ahead and what does it mean for investors?
Same ole, same ole
Some of the reasons behind the stock rally are quite familiar. Artificial intelligence remains a powerful narrative and these stocks remain key drivers of major indexes. In addition, heightened participation by retail investors has also been persistent through the year. Add in some end of year seasonality and investors have plenty of reasons to be optimistic.
Arguably the biggest driver of optimism, however, has been the shift to easier monetary policy. Clearly, investors have been expecting the Fed to continue easing, well after the cut on Wednesday. In addition, the end of the Fed’s Quantitative Tightening program also eases concerns.
Nonetheless, there are still a lot of risks that investors seem to be shunning. Credit problems continue to pop up with annoying regularity and evidence keeps mounting that consumers are getting squeezed.
Geopolitically, there is a whole grab bag of risks. Debt problems in France threaten the entire Eurozone, Russia’s war in Ukraine is an ongoing threat, and Japan is celebrating a new prime minister but still faces the intractable problem of too much debt and too little growth. Finally, as China’s new five-year plan made evident, the differences between it and the US are structural and will not be resolved with any trade “deals”.
Finally, even though monetary policy is easing, the liquidity environment has been tightening up. Indications such as elevated repo rates and increased use of the Standing Repo Facility have been expected as the Fed has reduced its balance sheet. While the Fed would almost certainly act quickly if liquidity dried up suddenly, the entire goal of normalizing its balance sheet is to expose liquidity to market-based discipline. Such discipline will counterbalance the benefits of monetary policy easing.
Adding all the pieces together, this list of factors that can undermine risk assets is not a trivial one. Why do investors seem so unconcerned?
One clue may also be part of the answer: Low volatility. With the exception of a brief flare up a couple of weeks ago, the VIX index declined rapidly and remained sedate since “Liberation Day” tariffs were announced in April. Perhaps even more impressively, the S&P 500 has remained above its 50-day moving average since May. That’s a rare lack of variation.
Bonds have also joined in on the fun with an even more impressive decline in the MOVE index (of bond volatility) since April. So, what’s the deal? What explains the dearth of volatility?
Carry on my wayward son
One interpretation that fits especially well is that the carry trade is ramping back up. Low volatility provides a favorable environment and both anecdotal evidence and foreign currency flows support the view.
I’ve discussed the carry trade in several reports (here, here, here, and here, for example). In each of those I have referenced The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis, by Tim Lee, Jamie Lee, and Kevin Coldiron, which is an invaluable resource for the analysis of the carry trade. Not only does the book identify what comprises a carry trade, it discusses why it has been such a prominent phenomenon in recent years and what it implies for future market activity.
For starters, the Rise of Carry describes in general terms how carry trades work:
October 2025
The third quarter was a good one for stocks in which they spent a good chunk of the time hitting fresh new record highs. In addition, while the path of travel for bonds was less smooth, the general upward direction (yields downward) was similar.
Such benign outcomes resulted despite an increasing array of risks. Why do stocks keep storming ahead and what does it mean for investors?
Same ole, same ole
Some of the reasons behind the stock rally are quite familiar. Artificial intelligence remains a powerful narrative and these stocks remain key drivers of major indexes. In addition, heightened participation by retail investors has also been persistent through the year. Add in some end of year seasonality and investors have plenty of reasons to be optimistic.
Arguably the biggest driver of optimism, however, has been the shift to easier monetary policy. Clearly, investors have been expecting the Fed to continue easing, well after the cut on Wednesday. In addition, the end of the Fed’s Quantitative Tightening program also eases concerns.
Nonetheless, there are still a lot of risks that investors seem to be shunning. Credit problems continue to pop up with annoying regularity and evidence keeps mounting that consumers are getting squeezed.
Geopolitically, there is a whole grab bag of risks. Debt problems in France threaten the entire Eurozone, Russia’s war in Ukraine is an ongoing threat, and Japan is celebrating a new prime minister but still faces the intractable problem of too much debt and too little growth. Finally, as China’s new five-year plan made evident, the differences between it and the US are structural and will not be resolved with any trade “deals”.
Finally, even though monetary policy is easing, the liquidity environment has been tightening up. Indications such as elevated repo rates and increased use of the Standing Repo Facility have been expected as the Fed has reduced its balance sheet. While the Fed would almost certainly act quickly if liquidity dried up suddenly, the entire goal of normalizing its balance sheet is to expose liquidity to market-based discipline. Such discipline will counterbalance the benefits of monetary policy easing.
Adding all the pieces together, this list of factors that can undermine risk assets is not a trivial one. Why do investors seem so unconcerned?
One clue may also be part of the answer: Low volatility. With the exception of a brief flare up a couple of weeks ago, the VIX index declined rapidly and remained sedate since “Liberation Day” tariffs were announced in April. Perhaps even more impressively, the S&P 500 has remained above its 50-day moving average since May. That’s a rare lack of variation.
Bonds have also joined in on the fun with an even more impressive decline in the MOVE index (of bond volatility) since April. So, what’s the deal? What explains the dearth of volatility?
Carry on my wayward son
One interpretation that fits especially well is that the carry trade is ramping back up. Low volatility provides a favorable environment and both anecdotal evidence and foreign currency flows support the view.
I’ve discussed the carry trade in several reports (here, here, here, and here, for example). In each of those I have referenced The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis, by Tim Lee, Jamie Lee, and Kevin Coldiron, which is an invaluable resource for the analysis of the carry trade. Not only does the book identify what comprises a carry trade, it discusses why it has been such a prominent phenomenon in recent years and what it implies for future market activity.
For starters, the Rise of Carry describes in general terms how carry trades work:
Carry trades make money when “nothing happens.” In other words, “they are financial transactions that produce a regular stream of income or accounting profits, but they subject the owner to the risk of a sudden loss when a particular event occurs or when underlying asset values change substantially.”
In practical terms, “The classic finance carry trade takes place in the foreign exchange market, when a trader borrows in a low interest rate currency and invests the proceeds in another, higher-yielding currency.” In more colloquial terms, this is referred to as “picking up nickels in front of a steam roller”.
While the carry trade certainly can be promoted by sophisticated hedge fund strategies, a lot of more recognizable, more pedestrian, activities also qualify. For example, buying higher-yielding stocks on margin, investing in structured products that produce income by selling volatility in some form, and corporations raising debt to repurchase equity all qualify as carry trades. The common thread is that in each case, “the carry trader is either explicitly or implicitly betting that changes in underlying capital values will not wipe out his or her income return”.
Most importantly, The Rise of Carry reveals that carry trades define the investment landscape in important ways. In other words, when a carry regime is in effect, there is not only a number of observable characteristics (such as low volatility), there is a predictable dynamic (e.g., increasing debt). In short, if you know you are in a carry trade, you also have a very good idea, albeit very generalized, of what is going to happen.
One characteristic of a carry regime is that it “results in a very suboptimal allocation of resources in the economy”. From a free-market perspective this is just common sense because a carry regime suppresses volatility below what would be established by the forces of a free market:
While the carry trade certainly can be promoted by sophisticated hedge fund strategies, a lot of more recognizable, more pedestrian, activities also qualify. For example, buying higher-yielding stocks on margin, investing in structured products that produce income by selling volatility in some form, and corporations raising debt to repurchase equity all qualify as carry trades. The common thread is that in each case, “the carry trader is either explicitly or implicitly betting that changes in underlying capital values will not wipe out his or her income return”.
Most importantly, The Rise of Carry reveals that carry trades define the investment landscape in important ways. In other words, when a carry regime is in effect, there is not only a number of observable characteristics (such as low volatility), there is a predictable dynamic (e.g., increasing debt). In short, if you know you are in a carry trade, you also have a very good idea, albeit very generalized, of what is going to happen.
One characteristic of a carry regime is that it “results in a very suboptimal allocation of resources in the economy”. From a free-market perspective this is just common sense because a carry regime suppresses volatility below what would be established by the forces of a free market:
The carry regime results in a suppression of interest rate spreads that rests on an assumption that central banks—and other governmental or multilateral institutions such as the IMF—will not allow excessive exchange rate volatility or asset price volatility in general and will effectively stand behind debt. This means that credit risk is mispriced from a free market perspective. It implies that there is an understanding that debt is at least partly socialized; the costs of default or failure will be at least partly shared across the economy, potentially the global economy, as a whole.
As a result, the carry trade “must fundamentally be a wealth-destroying process”. This is a very important point. For whatever reason a governmental institution may decide to engage in volatility suppression -- to buy time, to form a bridge to pass over an emergency, to reset sentiment, or whatever -- it is doing so at the expense of longer-term prosperity. Indeed, such a decision to forgo longer-term benefit for short-term expediency is the exact opposite of investing for the future.
Another characteristic is that central banks normally play a central role in turbo-charging a carry regime. After all, guidance about rates and asset purchases not only provide powerful signals about intent, but also costly deterrents for any adventurers who may be inclined to trade against government resources. If a major central bank wants lower volatility, it certainly has plenty of tools to accomplish that for at least some period of time.
In recent years, the Treasury has also gotten in on the act. Normally confined to preventing large moves in Treasury yields that could prove disruptive, the Treasury has become more aggressive in actively suppressing volatility. First under Janet Yellen, and now under Scott Bessent, Treasury has shifted issuance disproportionately to bills in order to prevent longer-term bond yields from rising too much. Regardless, it all amounts to the same thing: There is a prevailing institutional effort to suppress volatility.
Such efforts come with a sting though. As “central banks come to be seen as agents of carry — and carry comes to be properly understood as reinforcing inequality — then we can expect continuing challenges to their independence and objectives.” Indeed, the volume of such challenges has grown notably this year. These challenges didn’t just come out of nowhere and weren’t entirely partisan. Instead, they were eminently foreseeable. Treasury runs this risk as well.
A third characteristic of carry regimes is where the rubber hits the road for investors: “when carry trades become prevalent in any financial market, it becomes virtually inevitable that they will crash”. To repeat for those in the back, “it becomes virtually inevitable that they will crash”. As a result, the chances of a moderate correction have decreased and the chances of a disruptive decline have increased. That's just the way carry regimes work.
Arguably, the risk is even greater than that. Because “There is also evidence of a growing correlation between currency and equity market carry,” there is a good chance “that a single global volatility risk factor may be a driver of all forms of carry in the future.” As the book concludes, “If this is true, future carry crashes may impact all asset classes at the same time.” Ouch.
Implications
The most important and most obvious implication is that there are virtually no safe places for investors to go for safe harbor in the event of a carry crash. Stocks don't work. Bonds don't work. Indeed, any risk asset ... is at risk.
Again, the risk is probably even greater because in a carry crash, the very nature of money comes into question: “At the heart of the carry regime ... lies monetary instability”. Ultimately, “This means we need to prepare for potentially dramatic change in our monetary system, ultimately new monies, not reliant on central banks, will be likely to appear.” After all, if people can't trust the central bank to be a good steward of a country's money, why should they trust the money to retain its value at all? So, even cash isn't super-safe.
With such dire prospective consequences, it's a fair question as to why government authorities would ever allow a carry regime to develop, let alone to promote one. Certainly, mistakes get made, some individuals may not care as much about "other people's money", and hubris is always a possibility as well. A scarier possibility is they see volatility suppression as the least worst of a very bad set of policy options.
There is also another, even more sinister, possibility. The book states, “Those that survive [a carry crash] are almost always insiders with enough political and financial clout to either influence government policy or react very quickly to it.” In other words, it is entirely conceivable that government officials are facilitating the current carry regime for political purposes: Energize a system that is doomed to failure, and when it does fail, selectively offer support only to political allies.
This scenario could explain why Scott Bessent reached out to Argentina with an offer of financial support despite there being no clear public policy benefit for doing so. Not only does it help a personal friend of Bessent’s who had invested large sums in Argentina, but it also sends a broader message to the world: “If you are with us, you are eligible for a lifeline. If you are against us, you are on your own and life will be 'nasty, brutish, and short'.” In other words, the carry trade may be just one more vehicle by which the Trump administration imposes its influence.
Conclusion
In sum, while there is always a wide range of factors that determine market outcomes, there is a fair amount of evidence that a broadening carry trade is influencing recent activity.
Insofar as this is the case, investors get some valuable insight about the nature of the investment proposition. For one, a rising stock market is not necessarily a commentary on improving economic fundamentals. Rather, it is more directly a commentary on declining volatility and increasing leverage.
In the short-term, this means there is a decent chance stocks will keep going up. However, over the longer-term, there is also a very high chance of a major dislocation. This is good for short-term risk-takers and not so good for longer-term investors.
There are also economic and social implications. The longer a carry regime runs, the more misallocation of resources and value destruction there is. This is a better environment for short-term opportunists than for longer-term consumers, workers, or businesspeople.
Finally, leverage and proximity to power are key. It’s best to be extremely judicious about using leverage. If not, it helps to be well-connected or have friends who are. Otherwise, you’re asking for trouble.
Another characteristic is that central banks normally play a central role in turbo-charging a carry regime. After all, guidance about rates and asset purchases not only provide powerful signals about intent, but also costly deterrents for any adventurers who may be inclined to trade against government resources. If a major central bank wants lower volatility, it certainly has plenty of tools to accomplish that for at least some period of time.
In recent years, the Treasury has also gotten in on the act. Normally confined to preventing large moves in Treasury yields that could prove disruptive, the Treasury has become more aggressive in actively suppressing volatility. First under Janet Yellen, and now under Scott Bessent, Treasury has shifted issuance disproportionately to bills in order to prevent longer-term bond yields from rising too much. Regardless, it all amounts to the same thing: There is a prevailing institutional effort to suppress volatility.
Such efforts come with a sting though. As “central banks come to be seen as agents of carry — and carry comes to be properly understood as reinforcing inequality — then we can expect continuing challenges to their independence and objectives.” Indeed, the volume of such challenges has grown notably this year. These challenges didn’t just come out of nowhere and weren’t entirely partisan. Instead, they were eminently foreseeable. Treasury runs this risk as well.
A third characteristic of carry regimes is where the rubber hits the road for investors: “when carry trades become prevalent in any financial market, it becomes virtually inevitable that they will crash”. To repeat for those in the back, “it becomes virtually inevitable that they will crash”. As a result, the chances of a moderate correction have decreased and the chances of a disruptive decline have increased. That's just the way carry regimes work.
Arguably, the risk is even greater than that. Because “There is also evidence of a growing correlation between currency and equity market carry,” there is a good chance “that a single global volatility risk factor may be a driver of all forms of carry in the future.” As the book concludes, “If this is true, future carry crashes may impact all asset classes at the same time.” Ouch.
Implications
The most important and most obvious implication is that there are virtually no safe places for investors to go for safe harbor in the event of a carry crash. Stocks don't work. Bonds don't work. Indeed, any risk asset ... is at risk.
Again, the risk is probably even greater because in a carry crash, the very nature of money comes into question: “At the heart of the carry regime ... lies monetary instability”. Ultimately, “This means we need to prepare for potentially dramatic change in our monetary system, ultimately new monies, not reliant on central banks, will be likely to appear.” After all, if people can't trust the central bank to be a good steward of a country's money, why should they trust the money to retain its value at all? So, even cash isn't super-safe.
With such dire prospective consequences, it's a fair question as to why government authorities would ever allow a carry regime to develop, let alone to promote one. Certainly, mistakes get made, some individuals may not care as much about "other people's money", and hubris is always a possibility as well. A scarier possibility is they see volatility suppression as the least worst of a very bad set of policy options.
There is also another, even more sinister, possibility. The book states, “Those that survive [a carry crash] are almost always insiders with enough political and financial clout to either influence government policy or react very quickly to it.” In other words, it is entirely conceivable that government officials are facilitating the current carry regime for political purposes: Energize a system that is doomed to failure, and when it does fail, selectively offer support only to political allies.
This scenario could explain why Scott Bessent reached out to Argentina with an offer of financial support despite there being no clear public policy benefit for doing so. Not only does it help a personal friend of Bessent’s who had invested large sums in Argentina, but it also sends a broader message to the world: “If you are with us, you are eligible for a lifeline. If you are against us, you are on your own and life will be 'nasty, brutish, and short'.” In other words, the carry trade may be just one more vehicle by which the Trump administration imposes its influence.
Conclusion
In sum, while there is always a wide range of factors that determine market outcomes, there is a fair amount of evidence that a broadening carry trade is influencing recent activity.
Insofar as this is the case, investors get some valuable insight about the nature of the investment proposition. For one, a rising stock market is not necessarily a commentary on improving economic fundamentals. Rather, it is more directly a commentary on declining volatility and increasing leverage.
In the short-term, this means there is a decent chance stocks will keep going up. However, over the longer-term, there is also a very high chance of a major dislocation. This is good for short-term risk-takers and not so good for longer-term investors.
There are also economic and social implications. The longer a carry regime runs, the more misallocation of resources and value destruction there is. This is a better environment for short-term opportunists than for longer-term consumers, workers, or businesspeople.
Finally, leverage and proximity to power are key. It’s best to be extremely judicious about using leverage. If not, it helps to be well-connected or have friends who are. Otherwise, you’re asking for trouble.
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