Stock markets took a big hit Monday as investors sold off shares of U.S. companies and exited positions on the Japanese yen, which has been gaining in strength relative to the dollar following interest rate hikes by the Bank of Japan.
The Dow Jones Industrial Average of big U.S. companies closed down 1,033 points or 2.6 percent. The S&P 500 index finished 3 percent down, and the technology-heavy Nasdaq composite lost 3.4 percent in the sell-off.
Technology stocks, which have been soaring in recent months on enthusiasm for artificial intelligence, were hit particularly hard, with Nvidia Corp. down more than 6.7 percent on the day’s trading and Intel down more than 7 percent. Shares of major tech companies have faltered since last week after a string of lackluster earnings reports and layoff announcements.
The stock market downturn began Friday after the July jobs report showed slower job growth and higher unemployment than economists expected, stoking fear about the Federal Reserve's high interest rates suffocating the U.S. economy.
As the losses accelerated Monday, investors pointed to the unwinding of “carry trades,” a term for stock purchases using cheap foreign currency that has been borrowed and needs to be repaid, as the reason for the stock rout.
The Japanese yen had been cheap compared to the dollar due to super-low Japanese interest rates and elevated U.S. interest rates, falling as low as 160-to-1 earlier this summer.
But the yen has been gaining on the dollar since early July, ahead of an interest rate hike by the Bank of Japan to a 15-year high. The yen-to-dollar ratio has since strengthened to 144-to-1.
“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 around the world. And that was a great trade. It worked until it didn’t work. It stopped working when the Bank of Japan raised the cost of borrowing,” investor Ed Yardeni, president of Yardeni Research, told The Hill.
Treasury yields have dipped as investors have taken shelter in steadier government securities, with the return on the 2-year note falling below 4 percent for the first time in more than 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,” Joe Brusuelas, chief economist at RSM, wrote in an analysis.
Underlying the market turmoil, the U.S. economy is still in fundamentally good shape, analysts say, even as it nears a crucial inflection point for the Fed.
“This sell-off is solely based on vibes and positioning — not fundamental weakness. But it could be dangerous given investors are on edge and the economy is vulnerable with interest rates so high,” Callie Cox, chief market strategist at Ritholtz Wealth Management, wrote in a commentary.
The Friday jobs report from the Labor Department surprised to the downside, raising concerns among some policymakers and investors that the Fed may have erred in not cutting rates during a policy meeting last week.
“They clearly made a mistake,” said Mark Zandi, chief economist at Moody's Analytics, in a CNN interview Monday. “That’s, now, I think, obvious to everyone — including them. And I think they’re going to respond.”
The relative weakness in recent employment data, which has been uncharacteristically strong on the back of massive postpandemic federal stimulus, is becoming more of a concern for investors.
Investment bank Goldman Sachs increased its 12-month recession probability to 25 percent from 15 percent on Monday, saying it expects three consecutive rate cuts from the Federal Reserve in the remainder of the year to make sure the economy is properly stimulated.
“We now expect the Fed to deliver an initial string of three consecutive 25-basis point rate cuts in September, November, and December,” analysts wrote in a Monday note to investors.
Other banks expect the Fed to take bolder action and cut rates more quickly.
“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,” Wells Fargo chief economist Jay Bryson wrote in a special commentary published Sunday.
“We forecast the Committee will reduce its target range for the federal funds rate to 3.25–3.50 percent by the middle of next year, which is in the vicinity of what many observers … consider to be neutral,” he added.
The recent uptick in unemployment is also worrying because the most recent jobs report triggered a recession indicator known as the Sahm rule, which says the economy is in a recession when the 3-month rolling average of the unemployment rate climbs half a percentage point or more above its recent low point.
“That put it up over its half-a-percentage point threshold, noting that comes off of history experience,” Claudia Sahm, inventor of the rule, told Bloomberg on Friday. “This is seeing way too much momentum in the unemployment rate in recent months.”
“We’ve had enough slowing here — what levels this out?” she added.
Despite reverting yield curves in the bond market and the weaker employment numbers, other economic metrics are still quite strong, with gross domestic product rising 2.8 percent in the second quarter following a 1.4-percent rise in the first quarter. The Federal Reserve Bank of Atlanta is now predicting 2.5 percent growth for the third quarter.
Additionally, the Dow is up about 9 percent on the year, and the S&P 500 is up more than 14 percent annually. Gasoline prices and mortgage rates have been falling, with the 30-year fixed rate mortgage falling to 6.34 percent, according to Mortgage News Daily.
Some analysts don’t see Monday’s market turmoil as a sign that investors believe the Fed has overdone it and strong-armed the economy toward a serious recession. Rather, they see it as more of an indication that investors got too bold with their carry trades.
“We’ve basically had a lot of margin calls on a global basis on these so-called carry trades, and that’s why we’re seeing markets around the world taking a dive. It can’t possibly be just because we had a weaker than expected employment report on Friday,” Yardeni said.
