What happened last week.
(A forex, index, and commodity market review)
An extraordinary week where the markets were griped by fear of a major sell-off. Poor ISM Manufacturing data and a notable miss on the Non-farm employment data the previous week stoked fears of a significant slowdown and the possibility of a recession in the US. This coincided with a rate hike in Japan on the 31st of July which caused a chain reaction as the Japanese Yen rallied by 5% causing a sharp sell off in Japanese equities.
Weekly change (amount change and percentage change on the week)
FTSE -28 -0.34%
DAX +49 +0.28%
DOW -152 -0.38%
S&P +5 +0.09%
NASDQ +89 +0.48%
NIKKEI +407 +1.17%
Hang Seng +170 +1.01%
By the end of last week global equity markets had managed to recover all of what they had lost up to Wednesday, closing near unchanged on the week.
However there some significant falls on Monday as the fear and greed index, the VIX, which peaked above 65, its highest level since March 2023 when the US small / Midcap banking crisis occurred. The moves in the market were exacerbated with many key decision makers away on their summer breaks. What caused this magnitude of a sell-off? US data in the last week of July and first few days of August alarmed some investors, who were expecting the goldilocks scenario where the US economy remained robust but where price pressures continued to moderate, allowing the FED to execute their first rate cut since the start of Pandemic in March 2020. However, the manufacturing and employment data was not received well as investors immediately questioned whether the FED should have cut rates at the end of July. Concerns spread as investors and traders speculated about the risk of the US entering a recession in the next two quarters. The investment bank, Goldman Sachs, increased its risk rating of a US recession to 25% which helped drive forward interest contracts lower. Early last week, during the intensity of the sell-off, the Fed Watch Tool from the CME implied a 75% probability of a 0.5% cut in rates at the September 18th FOMC meeting.
The sell-off in US equities was not the only story that contributed to the sudden global panic in the markets.
We discussed the rapid appreciation of the Japanese Yen at the end of July / early August which was driven by the surprise hike in rates by the BoJ and the belief that the central bank has effectively embarked on a tightening cycle, with further rate hikes expected. This drove the Yen much higher, which in part was driven by the rapid unwinding of the Yen carry trade which many investors and hedge funds had used to such beneficial effect in enhancing their returns.
The risk of the carry trade is well known, and when the Yen started to rally, it become self-reinforcing as the rising yen caused more funds to cover their Yen shorts. The carry-trade strategy used by hedge funds and investors involves borrowing in a low-cost currency, like the Japanese Yen, with very low interest rates, then swap these Yen for US Dollars and invest in the high yielding investments such as the US technology sector and those magnificent 7 stocks that have done so well over the past 18 months.
Therefore, the other main symptom of the Yen carry-trade unwind, aside from the rush to close Yen shorts, was the rush to close those positions in these magnificent seven equities. So the unwinding of the Yen carry trade added to the burden of sellers exiting the technology shares, with the sentiment spreading very quickly to the wider market.
Last Monday, some commentators were also speculating that the Federal Reserve could cut rates without waiting for the next meeting on September 18th, although such a move may well have caused even more panic.
The stress and at some times panic of earlier last gradually dissipated , culminating with a significant rebound last Friday as investors were encouraged by the better-than-expected weekly initial claims which suggested the employment picture is not as bad as some had feared. The Japanese equity market also recovered with the Nikkei 225 ending up in positive territory on the week, despite falling by its biggest ever one-day fall of 13% last Monday.
Is this the end of the sell-off?
What we witnessed early last week was a potential shift in prospects for the US and Japanese economies. The worst is over as the storm lasted little more than a few days but is an example of the effects of deleveraging as investors gradually adjust back to normality, following the effects of ultra low interest rates and quantitative easing. The moves were made worse by reduced liquidity that is typical in late July and August.
Will this happen again? More than likely but it may take some time as these events usually explode from a base of low volatility. With the VIX now comfortably below its peak readings from a week ago, at 20.4 its reading is still the average of thirteen over the past year.
EURUSD +0.06 +0.06%
GBPUSD -0.42 -0.32%
USDJPY +0.14 +0.10%
The sudden fall in the US Dollar at the beginning of August, following the poor employment data, was in reaction to the belief that the FED would be making cuts of at least 1.25% by year end. These forward interest rate contracts have moderated over the past week with a 50/50 call for a 0.5% cut in September with at least another 0.25% to 0.5% cut by year end. This explains the modest gradual improvement in the US Dollar last week. With inflation data out later this week, traders will have a clearer picture by the end of the week as to what is likely to happen.
Gold -12 -0.49%
UK OIL +2.09 +2.70%
US OIL +2.34 +3.18%
Oil rebounded last week on growing concerns of an escalation in the middle East conflict between Israel and Hamas. Over the weekend the US dispatched an aircraft carrier and guided missile submarine to bolster Israel’s defence in the hope that this might dissuade Iran’s proxies from attacking Israel.
Data and events in the coming week
(What traders need to look out for in the week ahead)
A busy week again for markets with closely watched inflation data expected from the US and UK.
Monday
US Elon Musk interviews Donald Trump. Hardly newsworthy but worthwhile focussing on the Presidential race as Kamala Harris seems to be gaining in some of the key battle ground states. The Democrat party’s strategy of describing Trump as “weird” seems to have energised their base. The first debate between Trump and Harris takes place on September 10th.
Tuesday
UK Unemployment Claimant count. Moderating wage growth and a slowing labour market may help the BoE cut by a further 0.5% by year end but the new Labour government will not want to see the number of claimants rise like they did in Q2. 14.5K claims (32.3K last). Average earnings expected at 4.6% following an annualised rate of 5.7% in May.
US Core PPI. The costs of goods and services going into production – referred to as factory gate prices. Expected at +0.2% (+0.4% last). USD sensitive.
Wednesday
New Zealand Possible cut of 0.25% in interest rates expected. NZD sensitive.
UK CPI inflation data. Expected at 2.3% annualised, last at 2.0%. The base effect is the main cause as July 2023 saw CPI fall by 0.4% which falls out of the calculation. GBP and UK assets sensitive to this release.
US Core CPI. Expected at 0.2% month on month with an annualised rate unchanged at 3.3%. US Dollar and US assets sensitive to this release.
Thursday
China Industrial production and retail sales. China’s recovery remains patchy Retails sales continue to struggle.
US Core retail sales. Volatile trend in retail sales as consumers still fret over inflation and outlook for the economy.
US Two key readings on the manufacturing sector. Philly and NY states. The manufacturing sector country wide took a dip two weeks ago with the poor ISM Manufacturing data. Mixed data expected with a pullback in the Philly index expected. USD and US assets sensitive.
Friday
UK Retail sales. A rebound from last month’s surprise fall. This year’s data has been blighted by seasonal factors as the weather played havoc with retailers plans. 0.6% expected. GBP sensitive.
US UoM Consumer sentiment. 66.7 expected as sentiment continues to wane from early on this year as consumers continue to worry about inflation, whether real or imagined.
