The stock markets experienced significant downturns as investors offloaded shares of U.S. companies and withdrew from positions in the Japanese yen. The yen has been appreciating against the dollar following interest rate hikes by the Bank of Japan.
The Dow Jones Industrial Average closed down by 1,033 points, a decline of 2.6 percent. Similarly, the S&P 500 index fell by 3 percent, while the technology-centric Nasdaq composite dropped by 3.4 percent.
Technology stocks, which had seen substantial gains in recent months due to enthusiasm for artificial intelligence, were notably affected. Nvidia Corp. experienced a decline of over 6.7 percent, and Intel fell by more than 7 percent. Major tech companies have struggled since last week following a series of disappointing earnings reports and layoff announcements.
The market downturn initiated on Friday after the July jobs report revealed slower job growth and higher unemployment than anticipated. This sparked fears that the Federal Reserve's high interest rates might be stifling the U.S. economy.
As losses deepened on Monday, investors attributed the market rout to the unwinding of “carry trades.” These involve purchasing stocks using inexpensive foreign currency that has been borrowed and needs to be repaid. The Japanese yen, which had been cheap compared to the dollar due to low Japanese interest rates and high U.S. interest rates, was a significant factor. Earlier this summer, the yen fell as low as 160-to-1 against the dollar but has strengthened to 144-to-1 following an interest rate hike by the Bank of Japan to a 15-year high.
"A lot of speculators borrowed money in Japan at near-zero interest rates and then converted the yen they borrowed into other currencies to speculate globally. That was a great trade until it stopped working when the Bank of Japan raised the cost of borrowing," explained Ed Yardeni, president of Yardeni Research.
In response to the volatility, Treasury yields dipped as investors sought refuge in more stable government securities. The return on the 2-year note fell below 4 percent for the first time in over a year.
“As investors exited their positions in the yen, equity markets plunged, and yields fell across the Treasury curve as investors sought the safe haven of U.S. government securities,” noted Joe Brusuelas, chief economist at RSM.
Despite the market turmoil, analysts maintain that the U.S. economy remains fundamentally sound, although it is approaching a crucial juncture for the Federal Reserve.
“This sell-off is based on market sentiment and positioning rather than fundamental weakness. However, it could be risky given the heightened investor anxiety and the economy's vulnerability due to high interest rates,” commented Callie Cox, chief market strategist at Ritholtz Wealth Management.
The Labor Department’s jobs report on Friday raised concerns about the Federal Reserve's recent decision not to cut rates during their policy meeting. Mark Zandi, chief economist at Moody’s Analytics, remarked in a CNN interview, "They clearly made a mistake. That’s now obvious to everyone — including them. And I think they’re going to respond."
Goldman Sachs increased its 12-month recession probability from 15 percent to 25 percent on Monday, anticipating three consecutive rate cuts from the Federal Reserve later this year to ensure adequate economic stimulation.
“We now expect the Fed to deliver an initial string of three consecutive 25-basis point rate cuts in September, November, and December,” analysts at Goldman Sachs wrote.
Other banks predict even more aggressive action. Jay Bryson, chief economist at Wells Fargo, suggested in a Sunday commentary, “We now look for the [Federal Open Markets Committee] to cut rates by 50 basis points at its meeting on September 18 with another 50 basis point rate cut on November 7.”
The uptick in unemployment has also triggered the Sahm rule, indicating a recession when the 3-month rolling average of the unemployment rate increases by half a percentage point or more above its recent low.
“That put it up over its half-a-percentage point threshold, noting that comes off historical experience,” Claudia Sahm, who developed the rule, told Bloomberg. “This shows too much momentum in the unemployment rate in recent months.”
Despite the inverted yield curves in the bond market and weaker employment numbers, other economic indicators remain strong. The gross domestic product increased by 2.8 percent in the second quarter after a 1.4 percent rise in the first quarter. The Federal Reserve Bank of Atlanta predicts 2.5 percent growth for the third quarter.
Additionally, the Dow rose about 9 percent this year, and the S&P 500 increased by more than 14 percent. Gasoline prices and mortgage rates have been declining, with the 30-year fixed rate mortgage falling to 6.34 percent, according to Mortgage News Daily.
Some analysts do not interpret Monday’s market turmoil as a sign that the Fed has excessively tightened the economy. Instead, they view it as a reaction to overly ambitious carry trades by investors.
“We’ve had a lot of margin calls on a global basis on these so-called carry trades, which is why markets worldwide are diving. It can’t possibly be just because of a weaker-than-expected employment report on Friday,” stated Ed Yardeni.