Rob Hogg: Few Notes on Recent Market Turbulence

Contributing Factors 

Over the past several weeks markets have been exhibiting increased volatility, seemingly driven by a combination of factors:

• A sharp reassessment of the expected path of US monetary policy
• Weaker than expected outcomes in key US economic data reports (manufacturing and employment)
• Disappointing earnings updates from several of the “Magnificent 7” Mega-cap US Tech stocks, and
• A sharp appreciation of the Japanese Yen in the lead up to (and following) the latest policy tightening by the Bank of Japan

As a result, global equity markets have moved sharply lower in recent days on fears that the risk of recession may now be higher than investors had previously expected. Market interest rates have moved sharply lower for similar reasons.

Similarly, in Australia, the recently-released June inflation outcome has contributed to a change in investor expectations about the path of Reserve Bank of Australia (RBA) monetary policy.

 

The past week has witnessed three key factors contributing to changing sentiment.

US policy meeting

At their mid-week US policy meeting, the US Federal Reserve (the Fed) stated clearly that the timing of the first cut in policy rates is likely getting closer:

“the economy is moving closer to the point at which it will be appropriate to reduce our policy rate…the reduction in our policy rate could be on the table as soon as the next meeting in September.”

US economic reports

Two key US economic reports were weaker than expected, so increasing investor fears of recession and a potential US hard economic landing:

• The July ISM manufacturing report was far weaker than expected with the overall index declining to 46.8% (any number less than 50% suggests contraction in the sector)
• The July employment report recorded job growth of only 114,000 (following 179,000 in June) and the unemployment rate rose to 4.3% from 4.1%.

Australian Inflation

The Australian June quarter Consumer Price Index (CPI) rose by less than feared, with key underlying measures (the “trimmed mean” and the “weighted median”) both rising by 0.8% (the market had feared that an increase of 1% or more in these metrics might have forced the RBA to raise rates at their upcoming August meeting).

 

Magnificent 7: Generally disappointing updates

This calendar year has witnessed sharp share price increases in a number of stocks regarded as key beneficiaries of the Artificial Intelligence (AI) revolution – the so-called “Magnificent 7” comprising Nvidia, Microsoft, Meta, Alphabet (Google), Amazon, Tesla and Apple.

In the current quarterly US reporting season, several of these companies have disappointed investors with their earnings results and outlook statements. For companies such as these, whose share prices are trading at price/earnings (P/E) ratios higher than the market, any dousing of investor enthusiasm can have a sharp negative impact on pricing, as currently seems to be occurring.

 

Japanese Yen (JPY): A sharp appreciation

At times the JPY is used as a funding vehicle for so-called “carry trades” and it is likely that this year, as the JPY was depreciating, the JPY had been fulfilling this role again. However, as investors increasingly expected a further tightening in policy by the Bank of Japan in July, the JPY has appreciated sharply from around JPY/USD 162 to its current level of around JPY/USD 146. This has possibly led to the closing-down of some of these trades, which may also have contributed to some of the recent sharp moves in markets.

 

Equity markets: Reassessing the likelihood of a soft landing

The range of factors noted above has heightened some investors’ concerns that a US “soft” economic landing may not be as likely as had been previously hoped. Part of what is occurring is a downward adjustment in some investors’ growth and earnings expectations. Already, some market commentators are questioning whether the US Fed should already have cut interest rates with growth slowing, rather than simply alluding to the possibility of rate cuts occurring in September.

 

How much have equity and bond markets moved already?

As at Friday’s close, the US NASDAQ (which is most impacted by the performance of the Magnificent 7 stocks) has fallen by around 10% from its recent all-time high while the S&P 500 has slipped by around 6%. The Australian ASX 200 has retreated by less – just 2% – (owing in part to its smaller exposure to tech companies) but is likely to weaken further today.

As expectations for official interest rate cuts have accelerated, US 10-year yields have fallen by 0.6% from end June levels while 2-year yields have declined by almost 0.90% over the same period. In Australia, 10-year bond yields have declined by 0.26% to 4.05% while 3-year yields have fallen by 0.4% to 3.69% since end-June.

 

 

Read Rob’s previous macro updates

 

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