Global markets have been shaken by large and sudden moves during the last few days, to an extent unseen since the pandemic crisis (2020-21), global financial crisis (GFC, in 2008-09) or even earlier than that. On Monday August 7th, for example, Japan’s Nikkei 225 index dropped by 12.4%, its sharpest one-day decline since the 1987 Black Monday selloff. US equity markets fell by a similar amount: in particular, the Nasdaq composite fell by 13% since last month’s peak. European markets, which had lagged behind in the market run-up, have declined less, so far. Conversely, recession fears resulted in lower rates across the US curve: the 2-year US Treasury yields fell to 3.8%, causing the gap against the effective federal funds rate of 5-5.25% to widen by a greater amount than at any time since the GFC.
There are four main causes for this global repricing. First, recession fears in the US. These were sparked by an NFP reading of 114k in July that was well below expectations and recent averages, and by an increase in the unemployment rate from 4.1% to 4.3%. This increase in the unemployment rate has triggered the so-called Sahm Rule recession indicator. This rule “posits that a recession has begun once the three-month moving average of the unemployment rate exceeds its low from the prior year (2023) by at least half a percentage point.”
Second, there have been disappointing earnings from the tech sector. As reports suggest, the US “magnificent seven” high-tech stocks, including Nvidia and Apple, have accounted for most of the market price gains over the past year or so, significantly stretching their market valuations. Their recent disappointing earnings reports have triggered the correction, shedding nine hundred billion dollars in market value.”
Third, central banks’ pivot. In our latest column, titled “The World’s Major Central Banks Are At A Turning Point”, we discussed how the Bank of England had cut rates in August, the ECB had signalled a further cut in September, and the Fed signalled its readiness to beginning to cut its Fed funds rate in September. All this, while the Bank of Japan had increased its policy rate for the second time this year (after the hike in March from -0.1% to 0-0.1%), reaching “around 0.25%” (as the BoJ put it) for the first time since the GFC. The increase in Japanese rates coupled with the fall in DM – and EM – market yields implied an unwinding of the so-called Yen carry trade. The BIS estimated the “upper bound” of the yen carry trades conducted “on-balance sheet” to be JPY 40 trillion (around USD 270bn). The largest “victims” of this un-winding have been the Mexican and the Colombian pesos.
Compounding macro-financial reasons, the fourth cause is the rise in geopolitical tensions in the Middle East after the assassination of Hamas leader Ismail Haniyeh in Tehran, which Iran blames on Israel; there are increasing concerns of the extension of the conflict at regional level.
What has seemed like a global market rout in the last few days has been a healthy repricing of market valuations, the result of some changes to the fundamentals of the economy (US possibly headed for a recession), company earnings (in particular in the frothy tech sector), and central bank future moves. We believe that upcoming rate cuts in the US, Eurozone and BoE will further help stabilise the situation in coming weeks.
