SB Capital Insights

8/12/2024

Good morning. 

Investors remain cautious after a major selloff this past week. Sentiment remains mixed with calls for "buy the dip” and cries of an imminent recession. Markets were able to recover some losses but remain 2% down from the beginning of the Monday selloff.

The Fed has not responded to calls for an emergency meeting in the wake of recession fears. The Fed is likely to maintain its course, adhere to data, and conduct a predicted 25 basis point rate cut in September. 

Election

• Trump suggested that the president should have more influence over monetary policy. Trump is a proponent of cutting rates, and as president would likely replace Powell and assert more influence over the Fed. Historically the Fed has remained independent from the government, allowing it to make interest rate decisions that it believes are best for the American people while not influenced by politics.

• The “Trump trade” is a range of speculation that a Trump victory would mean corporate tax cuts, rate cuts, increased support for BTC, etc. However the election is much tighter now than it was in July, making this trade less popular. 

• Both candidates have agreed to a Sept 10th debate.

Keep reading as we take a look at key updates in the U.S. equity market and at Japanese markets.

Markets 

• This past Monday market participants from around the world experienced a historic global equity selloff. The selloff was sparked by a combination of factors, such as recession fears in the U.S. based on the tightening labor market, an unexpected interest rate decision by the Bank of Japan, and the overweight of tech stocks in the major indices. 

Important update on the U.S. Equity Market

• The United States equity market rebounded, closing near the previous week. 

• The technology sector was hit the hardest Monday, with Nvidia experiencing the worst of it. On the open Nvidia fell 13.24%, but cut back some of the losses throughout the day. 

(NVDA 8/2 - 8/6) Yahoo Finance 

• This marks the most 10-day volatility since March of 2023. The model below illustrates the past 10 days of the percent change in the S&P 500. It is clear that market participants are on edge, so brace for sustained volatility moving into this coming week. 

What’s going on in Japan? (With visuals)

Last week we explained how a poor jobs report and a selloff of highly weighted tech stocks influenced a global selloff. This week we will explain why a change in interest rate coming from the Bank of Japan was a major catalyst for the selloff.

Japan's stock market had a great year so far…

• A weak currency benefited its export reliant economy

• Years of deflation came to an end with the first inflation experienced

• Investor friendly: corporate tax cuts, share buybacks, and increased corporate investment

• Its major stock index, the Nikkei 225, had YTD returns of 17% before July 31

(Nikkei 225, Bloomberg)

Carry trade

• After rate cuts to promote growth in the wake of Covid-19, most central banks embarked on rate hiking cycles. This left Japan, with its historical negative interest rates, a source of cheap capital.

(SB Capital)

• The carry trade grew widely popular with investors borrowing the Yen at a cheap price, selling it for another currency (popularly the U.S. dollar), investing it in higher yield investments, and selling it to pay their Yen loan. This strategy saw immense growth and left investors with an attractive spread. It is hard to estimate but this source of cheap capital likely reached over $500 billion (UBS group).

  Departure from negative rates

• On July 31 the BOJ announced it would raise its short term interest rates to 25 basis points, the second rate hike this year.

• In its two day meeting it made strong implications that it would continue to raise rates.

"I do not necessarily view 0.5% as a barrier." 

(Bank of Japan Gov. Kazuo Ueda)

Resulting market madness 

• Japanese stocks suffered one of their largest single day losses ever in reaction to BOJ and U.S. economic data (explanation to come).

  • The Nikkei 225 was down 12% in a rapid market selloff.

• The Yen rapidly appreciated nearly 9% (July 31-August 5) as a result of increased rates.

(Yen exchange rate to U.S.$, Bloomberg)

Graph interpretation: When the Yen appreciates against the dollar, the amount of Yen that equals 1 dollar decreases. This is why a downward plotted line shows the Yen rapidly appreciating.

Aftermath

• BOJ Deputy Uchida capitulated to the markets and walked back the bank's plan to raise rates further in reaction to the selloff.

  • “Therefore, the Bank will not raise its policy interest rate when financial and capital markets are unstable”

• Japan's stock market has recovered some losses after the BOJ announcement. The Nikkei has gained 11% from its low in the selloff. This is similar to the U.S. market recovery, however with trillions in market value still lost.

• The Yen remains significantly stronger, despite some weakening. There is growing consensus that the Yen will continue to appreciate against the U.S. dollar.

  Making connections and sense of it

  • The Yen carried trade rapidly unwound due to a combination of recession fears and appreciation of the Yen. The carry trade relied on a stable spread between Japan's interest rate and popular U.S. equities. These events in combination put the spread in danger and led U.S. investors to rapidly withdraw short positions on the Yen. This led to a massive exodus by funds that heavily relied on the trade as a source of capital. This massive exodus from the U.S. markets triggered by risk simulations brought markets down.

Conclusion: The large amount of capital invested into U.S. markets funded by the carry trade was rapidly withdrawn. Investors bet heavily on this trade, but a stronger Yen in tandem with recession fears sparked a selloff in both U.S. and Japanese markets. This is a sign that as the U.S. begins to cut rates and faces a potential slowdown there are many factors to consider that are not only domestic.

What to look out for this week

• Tuesday: Home Depot (HD) earnings

• Wednesday: Core Consumer Price Index (CPI) MoM July: key inflation gauge used by the Fed

• Thursday: Retail Sales July, Walmart (WMT) and John Deere (DE) earnings

- Check out the official SB Cap Instagram account!  https://www.instagram.com/sbcap_insights/

Stay tuned for more content as we continue striving to be an exciting source of financial journalism.

We are two college students on a mission to immerse ourselves in the financial industry. We are eager to learn more and make new connections. Our goal is to share exciting and informative content that provides a broad picture of current events and offers valuable insights.

Authors: Ben Banchik, Zachary Singer

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