Good evening, as I write this brief update, the futures market is showing a positive opening tomorrow – while Japan’s Nikkei down 20% in last 2 trading days (currently up 10% overnight).

 

Although Canadian markets were closed (civic holiday), today’s S&P 500 sell-off was triggered by global economic concerns and a slowdown in U.S. job growth – as a reminder that stocks do not move in a straight line.

 

Nobody really knows what causes corrections, typically it’s a collection of events along with a mood or sentiment shift by investors….it appears the catalyst over the weekend, was the Yen Carry Trade, with US FOMC rate policy lag as a contributor.

Every 15-18 months on average a +/- 10% correction in risk assets is healthy to address excesses (especially huge borrowing positions) that inevitably accumulate and eventually need to unravel.

Year to date, trillions in wealth has been created and it stands to reason some pull-back in the trillions is expected.

 

With US Fed Reserve late to raise rates to fight inflation, and increasingly appears to be late in lowering rates, the market price action opens the possibility that markets could be on a precipice of something bigger?

Systemic shock (2008-2009) or a valuation repricing (2000-2002) which we appear overdue.

 

As a reminder the US Fed Reserve mandate is both Price Stability and Employment and will always act to intervene in the Credit Markets, if there is a threat to the credit system (2008-09) or the economy (2000-02, 2020).

 

Increasingly the US bond market is pricing in +/-90% probability of a 50-bps rate cut in September, while the Bank of Canada has already reduced rates twice @ 25 bps = 50 bps, with at least another 50-75 bps of cuts priced in by the bond market before calendar year-end.

 

Here are the key points:

• Global Selloff: Stock markets around the world experienced a noticeable decline. The Nasdaq Composite led the losses, and the Dow Jones Industrial Average dropped over 1,000 points. Japanese stocks, including SoftBank and bank stocks, were among the hardest hit.
• Tech Shares: The selloff in tech shares continued, with companies like Nvidia, Tesla, and Apple falling at least 4%. Apple also faced additional pressure due to news that Berkshire Hathaway had reduced its stake by +/- 50%.
• U.S. Economy Concerns: Investors are worried about a slowing U.S. economy. July’s job growth data showed a slowdown, leading to concerns that the Federal Reserve may need to catch up by cutting interest rates.
• Market Volatility: The VIX, Wall Street’s fear gauge, experienced its biggest intraday percentage gain since the Financial Crisis 2008-09. Turbulence started in Japan, where the Nikkei 225 fell more than 12%, the worst one-day drop since the 1987 crash after Black Monday.

Typically, a surge in VIX volatility takes 4-6 weeks to settle and signals a possible correction - historically bullish over the long term. Historically August, September, October and sometimes January are seasonally volatile months in the markets.

Treasury Yields and Service-Sector Data: Stocks and Treasury yields initially declined but later pared losses after better-than-expected service-sector data.

 

YEN CARRY TRADE EXPLAINED

1. Borrowing Yen: The yen carry trade involves borrowing money at near-zero interest rates in Japan and investing it in higher-yielding assets worldwide.Positions are unhedged which poses a currency risk if the value of the yen increases or the value of the dollar declines, traders must obtain more dollars to repay the borrowed yen or sell-off investment positions which can create significant fluctuations can lead to financial trouble.
2. Investing Elsewhere: They then use that borrowed money to invest in other assets, such as U.S. dollars or other currencies with higher interest rates.
3. Profit Strategy: The goal is to earn the difference between the low-interest rate they pay on the yen loan and the higher interest rate they receive on their investments.
4. Unhedged Positions: Yen carry trades are often not hedged, which means traders don’t protect against exchange rate changes. This lack of hedging can amplify risks, as unexpected rate hikes or cuts can impact the yen’s strength and affect carry trade profitability.
5. Risk and Unwinding: However, when the yen strengthens (as it did recently), investors rush to unwind these trades. They need more dollars or euros to pay back their yen loans, leading to market turmoil.
6. In summary, the yen carry trade is like a financial seesaw, balancing low-cost borrowing with potentially higher returns. But when the seesaw tilts unexpectedly, it can cause global ripples!

If you are interested in discussing further - please do not hesitate to reach out to our team.