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Anyone watching the markets on Monday was probably reminded of The Bangles’ song “Manic Monday”. Japan’s leading index, the Nikkei-225, slipped by 12.4% in the night from Sunday to Monday as global markets were unsettled by heightened expectations of a recession in the USA. The markets in Taiwan and South Korea, for example, also suffered, with losses of around 8% and 9% respectively.
In Japan and Korea, trading was temporarily suspended as planned by so-called circuit breakers due to the high losses. As the following chart shows, yesterday’s drop in the Nikkei-225 was the biggest daily loss since “Black Monday” in 1987.
The 10 biggest days of losses on the Nikkei-225
Quelle: Refinitiv Datastream
Weak labor market, strong yen and geopolitical risks
In our opinion, the reasons for the selling pressure, which began on Friday, were as follows:
1. Weak labor market data in the US: non-farm payroll employment rose by 114,000, the weakest reading since the end of the pandemic. In addition, the unemployment rate rose for the fourth month in a row to 4.3%.
This triggered a recession indicator observed by many market participants, the so-called Sahm Rule. This barometer compares the three-month moving average of the unemployment rate with its lowest point over the past twelve months. In the past, the barometer has been regarded as a very meaningful recession indicator and rose above the decisive value of 0.5 percentage points for the first time since the coronavirus crisis with the US labor market report.
Sahm Rule points to recession in the USA
Quelle: Refinitiv Datastream
2. Partial unwinding of carry trades in the Japanese Yen: This involves investors borrowing funds in the Japanese currency at relatively low interest rates in order to use them to make investments in other currencies that promise higher returns. The latest interest rate hike by the Japanese central bank and the appreciation of the Japanese currency in recent weeks have put this investment strategy under pressure. This in turn led to positions in more promising investments having to be liquidated.
Japanese yen significantly stronger recently (Exchange rate USD/JPY)
Quelle: Refinitiv Datastream
3. Geopolitical risks: In particular, the heightened tensions in the Middle East between Israel and Iran are causing concerns about an escalation in the region to rise again. Some media recently reported, citing several representatives from the USA and Israel, that a retaliatory strike against Israel announced by Iran and the allied terrorist organization Hezbollah could be imminent.
Losses across the board
Subsequently, the selling pressure was not limited to the Japanese market: In Europe, the Euro-Stoxx-50 lost 1.8% yesterday (Monday), the DAX in Frankfurt closed around 1.5% lower and the CAC-40 in Paris fell by 1.4%.
In the afternoon, the US stock markets also joined the general downward trend. The technology index Nasdaq 100 and the broader S&P 500 both ended the day down around 3%.
Yields on credit-safe government bonds have fallen significantly in recent trading days, reflecting both the flight to a safe haven and the expectation of many investors that the Fed could cut key interest rates more significantly due to the weak economic data. Yields on 10-year US government bonds are currently trading at around 3.75%, having been as high as 4.2% at the beginning of last week.
Tuesday, the markets have seen countermovement to the losses. In Asia, the Nikkei-225 was able to put the deep red start to the week behind it and gained around 10%. The Japanese benchmark index thus recovered at least some of Monday’s losses.
What does the sell-off mean for the markets?
We also believe that the risks of recession have increased in recent weeks. This is underlined above all by the weaker economic data in the US. At the same time, the US economy has so far proved surprisingly resilient. In addition, statistically based recession indicators such as the steepness of the US yield curve and the Conference Board’s leading indicator have failed in recent years. The Sahm Rule is an important recession indicator, but it is also only based on statistical relationships.
In our opinion, the market movements of the last few trading days are partly due to technical factors. These include the aforementioned carry trade in the Japanese yen, but also the fact that institutional and retail investors were heavily involved in promising investments. In addition, liquidity on the markets is lower in the summer. In such an environment, weaker-than-expected economic and corporate data is enough to trigger large price jumps.
A countermovement to yesterday’s losses was seen in Asia on Tuesday. The Nikkei-225 in Japan gained around 10%, making up some of the significant losses of the previous day.