Inflation is stable, the Federal Reserve isn’t aggressively tightening policies, and worries about a recession have eased in Q1 2026. What remains unclear is how much growth we will see, how patient policies will be, and how markets will react once we account for relief.

Market Transitions and Optimism

We are currently focusing on changes in the market rather than trying to find its peak. We’re looking at realistic optimism and spotting new risks. The big picture has shifted from preventing a crisis to observing secondary effects, with specific attention on a possible reversal in the yen carry trade. Concerns about this situation may be exaggerated since there are no strong signs of a major unwind. The price movements show cautious optimism, while there is increased sensitivity to funding risks that haven’t yet shown up. Japanese bond yields are rising, reaching levels not seen in over a decade. This change moves beyond previous yield suppression, making borrowing in yen more expensive. Traders are paying close attention to this shift. However, history suggests that destabilization only happens with rapid and chaotic yield changes, especially concerning US yields.

Risk Sensitivity and Market Participation

This situation doesn’t indicate an immediate crisis. Instead, it shows a lower tolerance for excessive borrowing, with adjustments in risk-taking happening before any potential unwind. This suggests a careful yet optimistic approach, where participation is reasonable but requires vigilance. As we move into early 2026, the environment seems to support a cautiously positive view on risk assets. The Federal Reserve kept interest rates steady in December 2025, and core inflation has moderated to 2.8%, meaning the toughest challenges are possibly behind us. Derivative traders might consider strategies that take advantage of continued, yet measured, growth in equity indices. However, a key risk is quietly growing around a possible unwind of the yen carry trade. The Japanese 10-year government bond yield has reached 1.25%, which is a level not seen in more than ten years, gradually increasing the cost of global trade funding. While this isn’t a crisis yet, it signals that the market is becoming more sensitive to changes in global funding conditions. Given this, buying protective put options on the S&P 500 or Nasdaq 100 for late Q1 2026 is a smart move. The VIX index is currently around a low 14, making insurance cheaper compared to previous years of uncertainty. This strategy allows traders to remain invested while protecting against sudden market drops if funding stress arises. To maintain positive market exposure, we suggest using bull call spreads instead of outright buying calls. This method clearly defines your risk and reduces entry costs. It reflects the belief that while the trend is good, large, unrestrained gains are less likely. This allows traders to participate in an ongoing rally without excessive exposure to rising volatility. Traders should also use derivatives on the USD/JPY currency pair as a key indicator of equity market risk. We’ve observed the yen strengthening through the latter part of 2025, and a quick acceleration of this trend could indicate a carry trade unwind is starting. Using options to position for further yen strength could directly hedge against this macro risk. Create your live VT Markets account and start trading now.

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