Last Monday’s violent correction, which wiped out trillions of dollars from global equity markets, is rooted in a historic swing in Japanese interest rates, overvalued technology companies, geopolitics and fears of a bigger-than-expected economic slowdown in the US .

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It is still too early to conclude that the volatility is over, with international markets moving between losses and gains. Japan’s central bank is expected to continue its policy of monetary tightening, not only raising interest rates but also reducing its bond purchases, despite reassuring statements by its officials that it will not move while market turmoil continues. This is likely to lead to a further repatriation of the yen, as many highly indebted Japanese firms will need to repay their loans. This trend could continue to weigh on the dollar and provide support to the euro as well as currencies less affected by global trends such as the Australian and New Zealand dollars.

Asset managers say the sell-off in carry trades, the practice in which investors borrow yen to buy assets in countries with high interest rates, is far from over, raising concerns that the jitters could spread to credit markets. , causing losses to some banks and possibly hurting the dollar. “The problem is that no one knows how many more carry trade positions will be closed and the interests at stake. “One of the things we’re watching is whether some banks are under pressure because they’ve lent too much, either to hedge funds or to private investors,” said Kun Goh, ANZ’s head of research. Through a series of questions/answers, Bloomberg tries to shed light on the forces driving today’s markets, after the recent turmoil, and predict what’s to come.

  1. Can the turmoil be compared to the Black Monday crash of 1987? This is a different situation. First, apart from Japan, which experienced one of the worst downturns in history, the losses are unrelated to those of 1987 and have different causes. First, there hasn’t been a real correction in the markets for a long time, and second, the recent rally has been characterized by too much concentration in the leading tech and Japanese stocks. Concerns about the economy were sparked when the sell-off in carry trade positions began, which in turn was triggered by rising interest rates in Japan and the resulting rise in the yen. That triggered a slide in Japanese stocks, which are highly vulnerable to the yen and the global growth outlook. The problem is that when some investors start losing money, it creates a snowball situation, and this is exacerbated by trading algorithms, options hedging tactics and limited trading volume in the middle of summer.
  2. Who suffered the most and who escaped? Asia was hit the hardest, with Japan at the center of the global sell off on Monday. At the same time, liquidations in carry trade positions hit the US technology hardest, as well as the markets of Korea and Taiwan, which are most dependent on technology. On the other hand, stocks in China, India and other Southeast Asian regions are emerging as winners of this new norm: From last Friday through Monday, Chinese stocks fell just 0.6%, while stocks in India and Malaysia gained 1 % and 3.6% respectively.
  3. Why was Japan at the center of this volatility? There is no single reason that explains this volatility, but several catalysts that have made Japan particularly vulnerable. First, the Japanese central bank raised interest rates and sent a “hawkish” message on July 31, pushing the yen higher. The belief among investors that Japanese interest rates would stay low for longer and the yen would remain low was shaken, signaling the exit for investors who traded on that outlook. Japanese stocks had hit record highs this year, making them more vulnerable to liquidations. Second, weak US employment data fueled concerns that the US economy is at risk of recession. The Japanese stock market is vulnerable to economic cycles due to Japan’s reliance on exports. It is also very liquid with a high proportion of foreign investors – so shares can easily be sold when concerns about the global economy arise. Third, there were many small investors who had bought Japanese stocks with borrowed money. So the sell off triggered a series of margin calls, forcing investors to close their positions as the value of the warrants collapsed, unless they had enough extra cash to cover the difference. This intensified the decline.
  4. Where do traders turn when markets crash? They are opting for safe havens such as 10-year US Treasuries, the yen and the Swiss franc, which have all strengthened. Surprisingly, gold fell, meaning some traders were forced to cover margin calls and therefore liquidated their positions in gold.
  5. How critical was the US employment data? It was just one piece of the puzzle. The accumulation of a series of negative news was the “culprit”. U.S. job openings had shown signs of slowing, just not enough to cause concern. On the macro front, signs that growth in Europe and China is slowing combined with weaker-than-expected US employment data indicated some slowdown. They have raised some concerns that central banks may have taken too long to cut interest rates to prevent a recession. This led investors to turn negative economic news into negative news for the market and believe that central banks are unable to deal with it. Some disappointing results from big tech in the US had already started to weigh on sentiment in July.
  6. Is this an early sign of a US or global recession? The recent turmoil in the markets has had no impact on the economy, which is slowing but has very little chance of slipping into recession in the next three to four months. But if there is further disruption in the market, then it could soon begin to affect the real economy and make a recession possible in the short term. But certainly, the recent turmoil in the markets shows that investors have suddenly become much more nervous about the state of the global economy. Investors are now discounting a more prolonged period of interest rate cuts than they did just a few weeks ago, meaning the Federal Reserve will have to cut rates more quickly to decongest the pressures.
  7. How will stock markets move from now on? Japanese stocks have recouped more than 70% of Monday’s losses and helped lead to a similar recovery in North Asian markets, which are heavily dependent on technology. It is still too early to make predictions. A market sell off usually develops in waves, as it happens in pandemics. A degree of calm has returned for now, but there may still be “some pain” that could trigger further losses.
  8. What was it that stopped liquidations? This was followed by better-than-expected data for the US services sector, which showed that the US economy remains in a strong state. Sentiment was further boosted by Bank of Japan Deputy Governor Shinichi Uchida’s statement that there will be no further interest rate hikes while markets are volatile. Of course this all came to a screeching halt as the selling reached an excessive point and investors came in and bought at the lows. However, the markets remain very nervous and no one dares to argue that the decline has bottomed out. Meanwhile, the data announced yesterday for unemployment benefit applications showed a larger than expected decrease for the previous week, which means that the labor market remains resilient.
  9. Can one partially blame the Fed for not cutting interest rates? In general, investors like to blame the Fed for the losses in their portfolios, but this upset is attributed to other factors, such as the closing of yen positions in the carry trade. Moreover, despite the brutality of the correction, the moves in US markets were not large enough to cause the Fed to worry. As central bank official Austin Goolsby said, “markets are much more volatile than the Fed’s moves.”
  10. What does the recent turmoil mean for cryptos? Cryptocurrencies were hit just as hard as stocks, with ether on Monday experiencing its worst daily drop since late 2021 and bitcoin losing $170 billion in market capitalization. What was shaken, however, was the narrative that bitcoin can act as a hedge against inflation and a safe haven in times of turmoil.
  11. How the course of oil and natural gas is prescribed; The oil market followed the general liquidations on Monday. When there are concerns about the growth of the economy, few asset classes can emerge unscathed from a market turmoil. However, interest returned to fundamentals – tensions in the Middle East and the prospect of supply from OPEC+, meaning oil regained lost ground.
  12. How will we know the storm has passed? Certainly the data to be announced in the coming days, on inflation and employment, will provide more clues. However, Wall Street’s famous fear index, VIX, could provide a better guide. While it has retreated from its highest level since March 2020 hit on Monday, it is still at levels twice the annual average.
  13. What is the outlook for central banks? Markets still expect the Fed to cut interest rates by more than one percentage point by the end of the year, meaning there could be three cuts, one of which would be 50 basis points. The Fed’s move is set to be more aggressive than that of the ECB, which is expected to cut rates three times this year.
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