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Japan became the epicentre of a global stock market rout this week.
Financial markets were rocked this week by spell of intense volatility. Major indexes were deep in the red across the USA, Europe and Asia, while sterling continued its recent freefall against its main rivals. Stock prices would quickly recover, yet lingering questions remained after a manic Monday.
At the centre of the storm was Japan, whose central bank had just taken interest rates into positive territory for the first time in over a decade. The volatility was caused not by that decision but by positions some traders had adopted because of its historically low interest rates.
If that all sounds slightly baffling, you aren’t alone. There were a couple of competing (but certainly intriguing) dynamics at play here that help to underline why panic can spread through markets like wildfire. We take a deeper look at what happened in today’s blog.
A tale of two banks
Even though the Bank of England recently decided to cut interest rates to 5%, two other central banks were in the spotlight: the Federal Reserve and the Bank of Japan.
No sooner had the Federal Reserve left interest rates on hold than volatility broke out. Even though Jerome Powell and co clearly signposted the first cut for September, disappointing jobs data quickly grew into calls for the Fed to announce an emergency rate cut. This felt excessive, although with unemployment climbing to 4.3%, policymakers soon found themselves under pressure to contain snowballing fears of a recession in the world’s largest economy.
Across the world, the Bank of Japan (BoJ) was faced with the fallout from an entirely different decision — to increase interest rates. With Japanese interest rates unbelievably low, many traders had adopted a strategy whereby they borrowed the Japanese yen at a massive discount to buy assets that offered a higher yield. That is known as a carry trade.
The fear was that as the BoJ’s path diverged from the Fed’s, investors would be caught in the middle, struggling to pay back the heightened cost of the original loans as the profits they took from previously attractive assets fell. These fears were assuaged by indications from BoJ policymakers that any further rate hikes would come slowly.
Tech rout
Underpinning all of this was a string of disappointing results from the tech industry. Nvidia, the new poster child of the chip industry, saw its share price slump by around 10% in just one day.
There was talk of a tech bubble, with some leading lights in the financial world suggesting that a price correction was long overdue. Apple, Tesla and Microsoft, along with other blue-chip names among the world’s largest companies, all struggled to fight off dips.
Many analysts have been saying the tech industry is overheated for some time now. Based on this evidence, it’s hard to argue with that. Yet the rapid change in tone was evidence of a deeply unstable market. As one trader quipped, when the Fukushima nuclear disaster happened, the Nikkei lost 6%. When the US posted poor jobs data and tech results, it shed 12%. Markets are temperamental and their movements are not always rational.
Currency in the crossfire
At times of volatility, currency markets cannot help but be caught in the crossfire. The Japanese yen has swung this way and that over the past week, with policymakers forced to intervene to prevent excessive losses.
The same frenzy that grips stock markets can quickly spread to the world of currency. We’ve seen it many times before, but often it takes a real-world example for the disastrous knock-on effects to become apparent. For businesses with overseas exposures, the scary thing is how quickly panic can take hold.
Make sure your profit margins are protected at all times. Speak to the experts today to see how you can protect your budget from currency risk.
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