Global markets go wild and woolly as U.S. economic outlook shifts
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Illustration: Aïda Amer/Axios
There is no reason that a 0.2 percentage point rise in the U.S. unemployment rate should trigger a 12% collapse in the price of Japanese stocks. Yet that's what happened Sunday overnight.
The big picture: The U.S. selloff on Friday was sensible, given signs of an economic weakening evident in July jobs data. The plunge in global markets that started Sunday night, however, looks to be driven by international financial linkages and crowded trades unwinding.
- Those effects are creating far bigger market moves than are justified by shifts in the U.S. economic outlook.
- That is a key reason the Fed will be reluctant to be seen acting rashly by cutting interest rates in advance of its Sept. 17-18 policy meeting, contrary to a swell of market chatter — and rising market-priced odds — since Friday.
- Why risk fueling further panic, in other words, when financial markets have already adjusted to make borrowing costs lower in anticipation of regularly scheduled rate cuts?
What they're saying: "The law" — meaning the Federal Reserve Act that authorizes the central bank — "doesn't say anything about the stock market, it's about the employment and it's about price stability," Chicago Fed president Austan Goolsbee said Monday morning on CNBC.
Between the lines: There are moments when markets just have a wild and woolly feel to them — when the scale of the moves is unmoored to the changes happening on the ground.
- It often happens when players with big, leveraged positions are forced to unwind them all at once.
- This looks like one of those times.
State of play: The unwinding of the Japanese carry trade is the most prominent and widely discussed of those shifts. For the last couple of years, a hedge fund could make easy money by borrowing cash in Japan, where rates have been stuck at zero, and buying U.S. debt instruments yielding 5% or more.
- Last week, the Bank of Japan raised rates, the Fed left them steady, and incoming economic data pointed to more aggressive Fed rate cuts in the months ahead — undermining the trade.
- As traders sought to repay yen-denominated debts to unwind the trade, they were forced to sell Japanese stocks, fueling the worst day for the Nikkei Index since the 1987 Black Monday.
Of note: It probably isn't a coincidence that this is happening in August, when many traders are on vacation and market liquidity dries up, fueling bigger moves.
- Such seismic events as the collapse of Long-Term Capital Management (1998) and a freeze-up of European money markets (2007) that was the precursor to the global financial crisis of 2008 also occurred in August.
