The three-day meltdown in Japan’s stocks that rocked global markets was so violent that it rewrote record books, according to Bloomberg.
The benchmark Topix index and the Nikkei 225 Stock Average each sank 12% on Aug 5, their steepest declines since the Black Monday crash in 1987. Over a three-day period, their tumbles were 20%, the most ever in Bloomberg-compiled data going back to 1959 for the Topix and 1970 for the Nikkei.
The value of shares traded on the Tokyo Stock Exchange’s Prime Market reached the highest level ever on Aug 5, at JPY7.97 trillion ($72 billion). The “fear gauge” of Japanese stocks, or the Nikkei Stock Average Volatility Index, surged to its highest ever that same day. Of the more than 2,000 stocks on the gauge, only 20 names rose on Aug 5.
Still, the gauges rebounded about 10% on Aug 6, staging their sharpest rally since October 2008, when stocks soared on government plans to support banks worldwide amid a deepening global credit crisis. Meanwhile, the MSCI Asia Pacific Index jumped as much as 3.9% early on Aug 6, following a rout of more than 6% the day before.
‘No reason to panic’
The recent market weakness did not happen overnight, says Vasu Menon, managing director, investment strategy, at OCBC. “It has been happening gradually and picked up pace in the past few days. After the strong gains in the first half, a short-term correction is not a surprise.”
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The first trigger for the recent selling, which “really started around mid-July”, was the tech rout after US big tech earnings missed forecasts, says Menon.
Concerns also emerged about the huge capex for artificial intelligence (AI) companies not yielding sufficient returns.
Investor positioning has also been crowded, says StashAway CIO Stephanie Leung. “This means that many investors have been piling into the same trade — for example, taking a short position on the Japanese yen versus the US dollar, or a long position on AI stocks. Crowded positioning makes the market vulnerable to sharp moves if they are unwound.”
The sharp appreciation of the yen, following the Bank of Japan’s unexpected rate hike to 0.25% from the 0%–0.1% range, contributed to a rapid unwinding in these positions — and in particular, the yen “carry trade”, a strategy that involves borrowing in a currency with a low interest rate and investing in a higher-yielding asset.
“The unwinding of these trades triggered a chain reaction across global assets, leading to other crowded positions also being unwound,” adds Leung.
Finally, weak US economic and jobs data released last week led to recession fears and concerns that the US Federal Reserve is behind the curve in cutting rates.
The Fed left interest rates on hold for the eighth consecutive time at its July meeting, despite some signs of softening inflation.
Days later, the US’s non-farm payrolls report showed that 114,000 jobs were added in July, well below the consensus expectation of 175,000, while the unemployment rate rose to 4.3%.
Goldman Sachs economists have increased the probability of a US recession in the next year to 25% from 15%, but say the Fed has a lot of room to cut interest rates and can do so quickly if needed.
Inter-meeting cut?
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With six weeks to go before the next Fed meeting on Sept 18, OCBC expects the Fed will initiate a 25-basis point (bp) rate cut, and only ease more aggressively by 50bps if August’s data is similarly weak. The Fed may cut again by 25bps in November as insurance against a recession but if inflation stays solid, Menon thinks the Fed will wait until December.
George Brown, senior US economist at Schroders, says the Fed’s signal for only one rate cut this year was “too hawkish” and left it unable to pivot swiftly in July.
“The Fed may cut by 50bps in September to make up for lost time. But the market is now pricing in five cuts by 2025, which is an overreaction,” he says, referring to expectations of one rate cut this year, and four in 2025.
Ray Sharma-Ong, abrdn’s head of multi-asset investment solutions, Southeast Asia, thinks a 50bps cut in September could happen.
But he also notes that the Fed did “meaningful” inter-meeting cuts in 2020 during the outbreak of Covid-19. “From Feb 26 to March 17, 2020, the Fed cut 50bps and 100bps consecutively, did it during off-scheduled meetings, and markets rebounded in a V-shaped manner.”
However, Pictet Wealth Management’s head of macroeconomic research Frederik Ducrozet and senior US economist Xiao Cui do not think current data warrants a 50bps rate cut in September, or an inter-meeting cut beforehand.
They write: “First, we expect a partial weather-related rebound in the August employment data. Second, hard data on spending and balance sheets suggests a labour market that is cooling in an orderly fashion. Survey data has been misleadingly soft for more than a year. Lastly, for an outsized/inter-meeting cut to happen, the FOMC [Federal Open Market Committee] would need to see more than one month of data to extract signals from the noise, or significant dislocation in the credit market.”
