Market Volatility
I wanted to take a moment and share some thoughts with you about the recent market volatility that has developed over the last couple weeks and a story that developed out of Japan over the August 3rd/4th weekend and the “Yen Carry Trade” that left us waking up Monday morning to a significant market sell-off. You may have already read about these events in the news but here is a brief update and a few of my thoughts on these events.
In a longer-term sort of big picture view, the “market,” or rather the collective buying and selling activity of all the participants like you and me, institutional investors (Wall Street), and pretty much anyone with an investment account, has been digesting some significant financial news in recent weeks and I believe it comes down to a couple key issues, the Fed Funds Rate, inflation & unemployment.
The Federal Reserve (Fed) began raising interest rates in March of 2022 to combat high inflation and reached the peak Fed Funds Rate of 5.25-5.5% in July of 2023. (For more context here is an interesting article with more detail on that period
www.thestreet.com/fed/fed-rate-hikes-2022-2023-timeline-discussion )
The Federal Reserve FOMC met the last week of July and decided to keep the interest rates steady but at the post meeting press conference Jerome Powell (Chairman of the Federal Reserve) seemed to indicate that they would be open to cutting rates in September. The market has been anticipating this move and effectively “pricing it in” for the last year. The market started to rally last October with the idea that beginning as early as January of 2024 the Fed would begin cutting rates. That didn’t happen, but with every passing month, every newsworthy economic indicator, or every Fed meeting, the market felt like we were getting closer and closer to the inevitable rate cut.
We saw market reactions that felt a little counter intuitive or opposite of what you would think… bad economic news basically meant that the Fed would be more likely to cut rates, therefore justifying the upward market moves from anticipated rate cuts. Good economic news on the other hand left investors feeling like rate cuts would be further delayed and the market, unable to justify its yearlong rally, would reverse course.
As much as “the market” would like to believe that lower interest rates are good for business and therefore good for investors, the reality is that the Fed is not making a decision about rates based on the market. Instead, the Fed would be lowering rates because there is some kind of economic indicator that would make them believe that the health of our economy needs the support of a lower interest rate to help the economy grow or to stave off some kind of economic problem.
Generally speaking, the Fed raises or lowers interest rates based on how the economy is doing, NOT to simply make investors happy, or make businesses more profitable through access to less expensive capital or lower borrowing costs. The Fed basically has two mandates, keep inflation low and employment high (or the inverse of that, to keep unemployment low). Inflation has come down from a year over year average of 8% in 2022 to 3% in June of 2024 and the preceding 12 months. During that same period, the unemployment numbers stayed between 3.5%-4% that is, until the most recent couple of months. The June unemployment report was 4.1% and the July report that just came out last week showed 4.3% unemployment. This uptick in unemployment is concerning for the markets.
The idea that the Fed would be lowering interest rates now (or in September) because of an uptick in unemployment rather than “just because the market would benefit from lower rates,” has caused investors to rethink what stocks should be worth if we were actually in need of a rate cut. So, we may be seeing a return to a more normal news/reaction environment, i.e. good news is good and bad news is bad… an uptick in unemployment does not mean that we are automatically destined for a recession. It does however imply that with less people employed and less income to spend that consumer spending could come down. And, since Consumer spending accounts for about 70% of our economy or GDP, if we see less spending we could see less GDP growth. Keep in mind that a recession is marked by 2 consecutive quarters of negative GDP, not just “less growth.”
Now for the more immediate, short-term news. On Monday August 5th we saw a significant drop in the market. This was kicked off in Japan on what would be our Sunday night, and bled into a Monday morning sell-off. The wall street analysts, and financial news media talking heads attributed this move to an unwinding of a multi-year carry trade. To give that a little context, a carry trade is when someone can borrow money at a low rate and then reinvest that money into something with a higher return potential. On Friday August 2nd, Japan’s Central bank decided to raise interest rates from effectively zero to .25% which is obviously a big contrast from the US interest rate environment. But if the anticipation is that our interest rates will be going down, and Japan’s interest rates will be going up, then the “Yen carry trade” (borrow Yen and invest in Dollars, or dollar backed securities…) will no longer be as viable of an investment trend. If you borrowed money to buy an asset, and now you want to repay the loan, you would have to sell the asset (or a portion of it) to come up with the money needed to pay back the loan. This sell-off is amplified by the sheer size and the nature of many large players all competing against each other to unwind their positions
It is my opinion that this is temporary, and that despite making investors nervous about an increase in volatility, the actual “Yen Carry Trade” is really not that different than it was a week ago… the Japanese central bank rate only went up .25% and the US rate has not been cut yet (we are just anticipating that it will get cut in September). However, the likely reason this has been so abrupt is because It’s kind of like ripping off a band-aid, it’s better to do a lot all at once and let the chips fall then to slowly unwind a position and risk being the last one holding the bag…
I hope you have found this helpful and thank you for taking the time to read through it.
Dave Baldwin CFP®
Share this Article
The Financial Advisor(s) associated with this website may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state. Please check Broker Check for a list of current registrations.
Dave Baldwin (CA Insurance Lic #0F04767) is a registered representative and investment advisor representative with/and offers securities and advisory services through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products and services are separate from and not offered through Commonwealth Financial Network®.
Tax preparation services offered through Talents Financial Planning and Wealth Management are separate and unrelated to Commonwealth Financial Network®.
Information presented on this site is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any product or security.
Form CRS: Client Relationship Summary
© 2024 All Rights Reserved | Talents Financial Planning & Wealth Management