The first days of August 2024 may be remembered as the worst in the world markets in the last couple of years. The worth of almost every asset fell significantly. What stands behind this rapid, sudden change?
The Domino’s Effect
To understand what is happening, we must go back to the unfortunate August 2nd, the day when crucial data was released: unemployment in the USA.
Unemployment reached 4.3%, not the forecasted 4.1%.
Despite the results being skewed by hurricanes in the USA (temporarily distorting the figures), the market reacts—and it reacts a lot.
- Rising unemployment triggers the #sahmrule indicator, signaling a recession. The Sahm Rule, created by economist Claudia Sahm, is an early warning indicator for recessions. It might be signaled when the three-month moving average of the national unemployment rate rises by 0.5 percentage points or more relative to its low during the previous 12 months. This rule aims to provide a timely and reliable signal of the start of economic downturns, allowing policymakers to respond more quickly to emerging recessions.
- This activates algorithms and triggers massive stock sell-offs, causing markets to plummet.
- Simultaneously, there is an increased demand for safe bonds, evident from the declining yields.
- Adding to the turmoil is Intel’s significant drop, contributing to negative sentiment in the media.
This is one factor but not the only one pulling the markets down.
To understand the next one, we must go back further to 2021.
Due to low interest rates and government policies, the yen maintained extremely low interest rates while other currencies saw hikes. This led to a 58% value loss of the yen against the dollar over three years. Japan, being the most indebted country relative to GDP, sees continuous currency weakening as problematic.
On July 12, the Bank of Japan intervenes, strengthening the yen. At the end of July, they raise interest rates, further boosting the yen.
Here, it’s important to explain what Carry Trade is.
Carry trade is an investment strategy where investors borrow in a currency with low interest rates (e.g., yen) and invest in higher-yielding assets. Reversing the carry trade means investors close these positions by buying back yen, further increasing its value.
Japan, concerned about the situation, is taking additional steps to strengthen the yen. It aims for a “short squeeze,” where investors must quickly repurchase the yen, driving its value higher.
This leads to margin calls for investors using leverage, forcing them to sell assets and creating a domino effect in global markets.
These are the two main factors complementing each other and negatively impacting the market situation. Some already speculate about sudden interest rate cuts in the USA and money printing to address the issue.
NIKKEI in a freefall.
As a result, Japan’s stock market suspended futures trade. The market dropped 8% after posting its worst losses since 1987.
Is there anything that rises?
The VIX, or Volatility Index, often referred to as the “fear gauge,” measures the market’s expectation of volatility over the coming 30 days. During times of market stability, the VIX tends to remain low. However, during periods of market stress, uncertainty, or significant declines, the VIX spikes as investors scramble to buy options to protect their portfolios.
So why is the VIX rising?
There are a few reasons.
- Market Uncertainty: The recent spike in unemployment in the U.S. and the subsequent fear of a recession have triggered a wave of uncertainty among investors.
- Geopolitical Tensions: Ongoing tensions in the Middle East are adding to the global instability, pushing investors to seek protection against potential market downturns.
- Algorithmic Trading: The activation of automated trading algorithms, which respond to market indicators like the #sahmrule, has amplified the selling pressure, further increasing volatility.
The VIX 100% spike
Implications for Investors
A rising VIX generally indicates that investors are expecting more turbulence ahead. This can lead to several outcomes:
- Increased Hedging: More investors will seek to hedge their portfolios against potential losses, driving up the demand (and price) for options.
- Flight to Safety: There will be a greater shift towards safe-haven assets such as government bonds, gold, and other low-risk investments.
- Market Correction: Continued high volatility often precedes a broader market correction, where prices adjust to reflect the new levels of risk.
Crypto Disaster
The crypto market has experienced true carnage. At one point, BTC slumped over 10% before recovering slightly to trade around $52k on August 5. The cryptocurrency has shed 24% over the past seven days—its worst week since the FTX collapse in 2022.
The decline in BTC and general concerns about global liquidity translate with double force into the situation on altcoins. ETH and Solana fell by up to 20% today (currently -13%). Investors should exercise particular caution due to the volatility in this market.
What Happens Next?
Given the current economic indicators and market sentiment, several scenarios could unfold:
- Federal Reserve Intervention: There is growing speculation that the Federal Reserve might step in with an emergency interest rate cut or other monetary measures to stabilize the markets. Such actions could provide temporary relief but might not address the underlying economic concerns.
- Global Coordination: Central banks around the world could coordinate efforts to provide liquidity and support to financial markets, similar to actions taken during past crises.
- Corporate Responses: Companies might revise their earnings forecasts and investment plans in response to the changing economic environment, leading to further market adjustments.
- Long-term Adjustments: Investors might shift their focus to more resilient sectors, which have shown relative stability during past downturns.
As we move forward, it will be crucial to monitor economic indicators, corporate earnings reports, and policy responses to gauge the market’s direction. Investors should stay informed and consider diversifying their portfolios to mitigate risks associated with high volatility.
The information provided on this website does not, and is not intended to, constitute investment advice; instead, all information, content, and materials available on this site are for general informational purposes only.
