- - Do you think it's a stock market tornado or just a thunderstorm?
On the stock markets today, there's a sense of relief: The global market downturn sparked by new recession fears hasn't continued, at least for now. Japan's stock market, which had plummeted at the start of the week, showed significant recovery. Just last Monday, the Nikkei 225 suffered a drop of over 12 percent. The German DAX and EuroStoxx 50 indices are fighting to stabilize on European exchanges, and a modest gain is expected on Wall Street. On the speculative market for cryptocurrencies, Bitcoin has recovered some of its massive losses from the previous day.
However, the situation on the capital markets remains challenging, with multiple stress factors. Experts cite several reasons for the recent downturn, including disappointing earnings from major U.S. tech companies, waning enthusiasm for Artificial Intelligence (AI), fears of escalation in the Middle East conflict, and particularly, the monetary policy of central banks.
Divergent Monetary Policy
Many major central banks have raised interest rates significantly in recent years to combat high inflation caused by the COVID-19 pandemic and the Ukraine war. While this therapy has been effective in taming inflation, it may have gone too far, potentially hitting the economy too hard, according to experts.
Last Friday, unexpectedly weak economic data, particularly from the U.S. labor market, was released, raising fears that the U.S. Federal Reserve (Fed) may keep interest rates too high for too long. Investors worry that high interest rates have made investments and loans so expensive that the world's largest economy, the United States, could slip into a recession, with corresponding negative global impacts. As a result, investors are already betting on surprising or significant Fed rate cuts to boost the economy.
Meanwhile, the Bank of Japan (BOJ) recently surprised markets by raising interest rates again, aiming to halt the decline of the Japanese yen. This divergent approach by the Fed and BOJ created a dangerous cocktail for global markets, leading to significant speculative trades in forex and stock markets being unwound.
"Summer Storms" or "Tornado"?
Such speculative trades are known in the industry as "carry trades." "I think we're currently seeing carry trades unraveling," says Roman Przibylla, an investment expert at Maverix Securities. When the yen fell to its lowest level against the U.S. dollar in nearly 30 years a few weeks ago, many investors borrowed money in low-interest Japan and invested it in high-interest countries like the U.S.
Now, however, the BOJ has raised interest rates. Przibylla emphasizes that this happened simultaneously with weak U.S. economic data, which suggests possible aggressive rate cuts. This led to speculation running in the wrong direction in both Japan and the U.S., causing significant holes in many investors' portfolios. When these trades result in losses, experts say investors must sell assets like stocks, contributing to the market downturn.
No significant concerns are expected from the unwinding of "Carry Trades", according to Przibilla: "The current turmoil suggests that we're dealing with a summer storm, not a tornado." Events of this nature typically last several days and cause increased volatility in the stock market. Investors can take advantage of lower prices to buy or add to high-quality stocks.
Geopolitical Risks
Moreover, experts doubt that the U.S. is heading into a recession. Recent fears are exaggerated, and there's no reason to panic, says Robert Greil, chief strategist at Merck Finck private bank: "The July employment report may indicate a slowing growth pace, but it was also influenced by some special factors." Other indicators, such as the Institute for Supply Management's services sector PMI released on Monday, show positive trends in employment and orders.
However, investors should continue to monitor geopolitical risks. "The conflict in the Middle East following the Hamas attack on Israel on October 7, 2023, is adding significant uncertainty to the financial markets," warns Jan Viebig, chief investment strategist at Oddo BHF private bank. Recent developments in the region have increased the risks of the conflict escalating. If Iran openly joins the fight against Israel, it could have severe repercussions on the financial markets.
The Commission, in response to the economic turbulence, might consider adopting implementing acts to provide clarity on the application of this Regulation, aiming to stabilize the capital markets. The potential impact of geopolitical risks, such as the escalation in the Middle East conflict, on the financial markets underscores the need for timely and effective regulatory actions.
