What a difference a month makes. In July, stock indices in the United States hit all-time highs, led by an artificial intelligence (AI) investment boom that steered technology giants like Apple, Microsoft and NVIDIA to historic levels.
Investors had earlier brushed off some signs that the US economy was slowing down but did an about-face when a disappointing job markets report, released Friday, showed that US firms hired nearly a third fewer workers than expected in July — 114,000 vs. 175,000 that were forecast. US unemployment also ticked up to 4.3% from 4.1% the previous month, forewarning the heightened risk of a recession.
On the other side of the world, Japan's central bank last week raised interest rates, causing a further rise in the Japanese yen against the US dollar. Investors, who had borrowed money in yen and bought stocks, commodities and bonds in dollars, suddenly faced higher loan costs and and foreign exchange losses. Cue the stock market rout.
US, Europe see huge drops, Japan falls off a cliff
After a large fall on Friday, global stock indices continued their rout on Monday. Japan's Nikkei 225 index plummeted at one point by 13.4% — its largest single-day drop since Black Monday in 1987. Japanese stocks had already fallen nearly 6% during the previous session. The Nikkei showed signs of recovery on Tuesday, closing up 10% higher than the previous day.
The US tech-heavy NASDAQ index lost nearly 9% over the past two trading days, while the S&P 500 — comprising the 500 largest firms on US stock exchanges — fell 4%. European markets were also down sharply. Wall Street's so-called fear gauge, the VIX index measuring stock market volatility, jumped to 50 — its highest level since the middle of the first COVID lockdown in April 2020.
"[Stock] valuations were on the high side by historical standards, so any perception of bad news could have triggered what we saw today [Monday] and the end of last week," Antonio Fatas, a professor of economics at INSEAD Business School, Singapore, told DW. "But I don't see anything solid enough [in the US jobs data] to switch to a very pessimistic mode."
New temper tantrum from investors?
Fatas compared the latest market volatility to the 2013 so-called Taper Tantrum when former Federal Reserve Chairman Ben Bernanke suddenly halted the central bank's asset purchases under a so-called quantitative easing program that helped the US economy out of the 2008/9 financial crisis. The decision sparked a 10% selloff in global stock markets and hurt emerging-market currencies. But they quickly recovered.
Another indicator of an impending US downturn was partly credited for the current selloff. The so-called Sahm Rule, named after its creator, US economist Claudia Sahm, states that if the three-month unemployment-rate average has risen by at least 0.5 percentage points above its low point in the previous 12 months, a recession will follow. The rule has signaled every recession since 1970. It got triggered Friday, the same day as the US jobs report.
US economy is still booming
By many other measures, the US economy remains healthy, growing a strong 2.8% last quarter, beating analyst forecasts. While inflation remains above the Fed's 2% target, it has dropped significantly from its 9.2% peak in June 2022. Consumer spending and business sentiment rose in the second quarter, strengthening forecasts that the US economy could achieve what's known as a soft landing without a recession, despite interest rates remaining at more than two-decade highs.
The payrolls data, however, and a lackluster US manufacturing report, released last Thursday, have fueled concerns that the Fed should have cut interest rates earlier in the year and that a recession is increasingly likely. US investment bank JP Morgan puts the probability of a recession at 50%, while Goldman Sachs analysts are more bullish at 25%, but up from 15%.
Many analysts think the US central bank could cut rates more aggressively in the fall. Some even believe Fed Chair Jerome Powell may be forced to make an emergency rate cut this month.
"I'm calling for a 75 basis point emergency cut in the Fed funds rate, with another 75 basis-point cut indicated for next month at the September meeting — and that's minimum," Jeremy Siegel, an economist at the University of Pennsylvania's Wharton Business School, told CNBC on Monday.
Skepticism is also rising about how long the AI investment boom can continue. Hong Kong-based research house Gavekal wrote in a report Monday that the selloff was a sign that the bubble "has started to implode."
Gavekal questioned the recent disappointing earnings from some US tech giants that showed a lack of returns despite "significant investments" in AI.
Tech earnings disappoint
Another sign of imminent doom was the lackluster earning reports of the top-performing US tech stocks, including Amazon, Microsoft and Tesla. The NASDAQ has been turbocharged by the so-called Magnificent Seven stocks, which also include Apple, Nvidia, Alphabet and Meta.
These companies are driving the massive investment boom in artificial intelligence (AI) platforms and have seen their valuations skyrocket over the past 18 months. But in the rout of the past two days, their stocks have fallen sharply — at one point NVIDIA's stock had fallen by 15% in two sessions.
End of yen carry trade?
The impact of rising interest rates in Japan — held at 0% or negative for nearly 17 years — also helped spur the boom in US tech stocks, through so-called carry trades. This refers to when money borrowed in a currency with low interest rates, is used to buy higher-yielding assets elsewhere in the world and profit from the difference.
Some economists believe the Bank of Japan's interest rate hike — albeit to 0.25% — and a strengthening of the yen against the dollar has sparked an unwinding of the yen carry trade, and that investors could steer clear of Japan for the foreseeable future.
US business daily The Wall Street Journal (WSJ) reported that investors had held over 180,000 contracts, betting on the yen weakening, worth $14 billion (€12.78 billion) at the beginning of July. Those positions had shrunk to $6 billion by last week, WSJ said, citing data from the US Commodity Futures Trading Commission.
"The carry trade is a form of speculation. They tend to work well until they don't," Fatas said, expressing his surprise that some investors "cannot even absorb a 0.25% interest rate."
Despite traders unwinding their positions, Fatas is confident that the Japanese economy is strengthening. Second-quarter GDP is expected to come in at 2.1%, a survey of economists polled by Reuters news agency found. In the previous quarter, the economy shrank by 1.8%, according to revised government data.
[Hiking the interest rate] was a policy change that had to happen one day. But I don't see a massive change in the plans of Japan's central bank," the INSEAD economist told DW. "And from a macroeconomic point of view, I do not see this as a fundamental shock to the Japanese economy."
