World stock, drop, roll

When two weeks ago the stock markets had taken a tumble to close the week out on a weak July jobs report and several other excuses depending on how aggressively, you wanted to frame the pitch of a potential recession. This past week continued the tumble with stocks dropping hard from the opening bell. On Monday, August 5, the Nasdaq, Dow, and S&P all finished more than 2.5% lower on the day. A large move lower especially considering that it was coming off a similar 2-day slide the previous week.

Why now? As mentioned, the earlier sell off was seen as a combo of recessionary concerns backed up by 2-3 months of weaker jobs report data and perhaps a building crescendo of concern about what this year’s election results will bring as campaigns pushed into uncharted waters. These narratives certainly provided the bears with fuel for a fire but seemed to lack the spark as they were mostly known before the slide. The spark appears to have come from the now infamous “yen-carry trade.” Simply put, the yen-carry trade is a long-standing foreign exchange strategy that seeks to take advantage of cheap interest rates and a cheap currency in the Japanese Yen. In the most simplistic terms, traders are short the yen, while being potentially long, anything else in an offsetting manner. As Japan has been engaged in a multi-decade long battle against an economy suffering from sagging inflation to outright deflation, it’s been a popular trade for foreign investors. Last week the Bank of Japan (BOJ) announced they would be raising the target interest rate on government bonds and sharply reducing the amount of bonds it buys as part of its efforts to control interest rates. The move looks to take the Japanese 10-year government bond rate from its current level of zero or .1 percent to a .25 percent target. Small in comparison to the U.S. government 10-year bond rate currently hovering around 4% but more than double where the rate currently stands. It’s not just the yen value or the BOJ interest rates on their own either, it’s the narrowing of the gap between them and everything else, whether it be a stock market retreating from the highs, U.S. interest rates looking to pull back with a more dovish FED or the raw price of commodities drawing down from recent highs.

Last Monday traders rushed for the exits on the yen-carry trade and found the exits were crowded. The rest of the week was a back-and-forth battle that kept equity markets above Monday’s low and well below the earlier week’s highs (as of Friday morning). Time will tell whether the yen-carry trade is blimp on the radar simply marking a change in trading procedures or the catalyst for a deeper recessionary pullback.