The recent sell-off in global markets on Monday was triggered by concerns about the US economy and the unexpected slowdown in hiring, leading traders to unwind their bets. Japan experienced the biggest sell-off since 1987, with its Topix index plunging over 12%. This turmoil spread to European markets and was expected to impact Wall Street later in the day.
The sell-off was fueled by fears that global policymakers, especially the US Federal Reserve, may struggle to control inflation without causing significant damage. Corporate executives have indicated that consumers are cutting back on spending, adding to concerns about the economy. Goldman Sachs raised the probability of a US recession in the next year, further unsettling investors.
The sharp decline in global equities was also influenced by the shift away from negative-rate policies in Japan and concerns about the expensive valuation of stocks. The rise in equities earlier in the year, driven by hopes of a Goldilocks economic scenario, made stocks look overvalued. The Vix index, a measure of market volatility, surged to its highest level since the Covid-19 pandemic, indicating more turbulence ahead.
The tech sector, particularly the Magnificent Seven tech stocks, had a significant impact on the market downturn. These stocks, which accounted for a large portion of the S&P 500 returns, faced pressure, contributing to the overall sell-off. Japanese stocks were hit hardest due to the Bank of Japan’s more hawkish stance, causing an unwinding of carry trades and erasing all gains for the year.
This interplay has caused the yen to surge more than 12% against the US dollar since the end of June, reaching ¥142.5. This significant movement in currency markets is posing a major challenge for Japan’s exporter-heavy stock benchmarks.
Japan’s stock market, which is closely linked to the global economy, is a natural target for risk reduction when large international funds switch to panic mode.
Despite recent optimism about Japan’s economic resurgence and the record highs achieved by Tokyo stocks in July, the market’s foundation has always been fragile. Domestic investors lacked strong conviction, leaving the recent rally largely dependent on foreign investment.
This reliance on foreign investors means that they can quickly exit the market, as they have done recently, causing significant market fluctuations.
Is the US Federal Reserve the Culprit?
While the Federal Reserve’s decision to maintain interest rates above 5% was in line with investor expectations, the weak July jobs report triggered concerns about a potential US recession. The slower job growth and rising unemployment rate raised fears that the Fed may have delayed lowering borrowing costs, increasing the economic risks.
Market expectations now include a prediction of 1.25 percentage points in Fed rate cuts by the end of the year, with speculation about the possibility of an emergency rate cut before the September meeting. Traders are closely monitoring economic data to determine the necessity of rapid rate cuts in response to the July labor report.
Additional reporting by Leo Lewis
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