The Cambridge Weekly –12th August 2024

The Cambridge Weekly – 12th August 2024

Market correction turns into pothole

Our sign-off last week was cautiously optimistic – predicting a bumpy ride to a decent destination in markets. Cue the worst daily loss for the S&P 500 in nearly two years at the beginning of last week after a terrible session in Japan, and sharp losses for most other major indices. US recession fears – stoked by a distinctly disappointing jobs report the previous Friday – formed the backdrop for the sell-off, however, market liquidity concerns emanating from Japan’s actions were the spark.

Japan’s carry-trade catharsis

It has been a long time since the Bank of Japan (BoJ) received this much global media attention. The bank has raised rates twice this year after nearly a decade of stasis – and its most recent hike set off the worst day for Japanese stock traders since 1987. Its policy stance has had a huge impact on western markets too: near-zero rates weakened the yen and provided a cheap source of funding for leveraged investors for most of 2024. Rising Japanese rates (and falling US rates) together with a strengthening of the Yen, have now reversed those trends and drained that funding. Journalists have called it the ‘carry-trade unwind’ and it is one of the reasons behind US stock market troubles in recent weeks.

Interest rate expectations

Opinions vary on how central banks should steer through capital market turbulence. Global investors, spooked by a weaker-than-expected US jobs report and a potential recession, were in a panic recently. Government bond yields dropped sharply in response – reflecting an expectation that central bankers will cut interest rates more rapidly and more sharply than previously indicated. But some renowned economists, including Mohamed El-Arian and Barry Eichengreen, argue monetary policymakers should hold their nerve – sticking to the plan, even if it upsets markets in the short-term.