Global markets kicked off this week with some very sharp volatility, reminiscent of historic crashes. Triggered by a surprise rate hike in Japan and concerns over a slowing US economy, major markets convulsed across the board, especially in Asia and Japan. Notably, that unexpected rise in Japanese interest rates and yen strength continued to see the unwind of the Japanese yen carry trade, causing widespread unease.
Huge sell-off in Asia
The upheaval bore a partial resemblance to the infamous “Black Monday” of October 1987, when the benchmark S&P 500 lost 20% in a single day. Instead, this was seen in Japan, as the Nikkei 225 suffered one of its worst single-day losses, closing over 12% lower. Similarly, in Korea, the Kospi tumbled by nearly 9%, prompting a rare 20-minute trading halt—the first such interruption in four years, triggered by a rapid more than 8% drop within a minute.
In the US, the impact was less severe. The Dow Jones Industrial Average (DJIA) fell by 2.6%, while the broader S&P 500 and the tech-focused Nasdaq declined by 3%. But these drops extended a week of losses, with the Nasdaq down over 13% from its record July high. US Treasury yields also tanked with rate cuts being very aggressively priced into Fed expectations. Indeed, at one point, there was a high chance of a 25bps Fed rate reduction within the next week.
Additionally, the VIX, Wall Street’s fear gauge, spiked higher. It surged from around 17 a week prior, to peak above 65 on Monday morning. By the close of trading, it had moderated to 38, its highest close since 2020.
Reason for the momentum crash
It seemed like a perfect storm hit markets, with a few critical factors contributing to the global market meltdown. Mounting fears of a US recession after a particularly weak July jobs report spurred investor anxiety. Friday’s weak employment data across the board pointed to sluggish job growth, combined with the unemployment rate rising to 4.3%, its highest since October 2021.
Last Wednesday also saw an unexpected increase in Japanese interest rates by 15 bps to 0.25% from nearly zero that further disrupted the yen “carry trade”. This strategy, which involves borrowing at low-interest rates in Japan to invest in higher-yielding assets internationally, had been popular among investors seeking to capitalise on the interest rate differential. However, the rate hike, coupled with the anticipation of cuts by the Federal Reserve, led to a stronger yen and market sell-off as large funds faced margin calls. Other factors which added to the risk-off environment included rising geopolitical tensions in the Middle East and the announcement that Warren Buffett’s Berkshire Hathaway had cashed in a large stake in Apple.
Going forward
Markets have calmed down more recently with stocks, the dollar and yields rebounding. The key thing to remember with these types of market moves is that we are deep into “summer markets”. Many traders at big investment banks and hedge funds are away on holiday. That means liquidity and volumes are much thinner than normal, which ultimately can result in very sharp, and sometimes inexplicable, price action. Of course, there are some themes which could endure, like the softer US data, but they do not warrant some of the volatility we have seen.
A lot of the price action has been put down to the unwind of the yen carry trade. This has seen a cheap source of funding for popular tech, gold and crypto long positions, disappear as the yen has strengthened hugely in a very short space of time. That has resulted in forced selling by funds caught on the wrong side. Going forward, the impact of a more hawkish Bank of Japan and dovish US Fed could be an important market driver if policy normalisation by the BoJ continues. That said today, we have seen dovish messaging from BoJ officials which has forced the yen sharply lower to underperform.
The dollar is expected to remain under pressure, even when stability in stock markets returns, as the Fed will kick off its policy easing soon. Money markets have got ahead of themselves by pricing in too many rate cuts in the near term. US CPI data next week will be key, as will the next NFP report at the start of September. As a Fed official reminded us on Monday, it was only one soft jobs report last week so the Fed will not react immediately to that. Gold could also regain its footing amid ongoing geopolitical tensions and expectations of Fed rate cuts.
