Market rout has more to do with end of cheap funding than U.S. economy

World equity market meltdown due to carry trade unwind, not U.S. economic shift; analysts predict limited market shake-up.

The meltdown in world equity markets in recent days is more reflective of a wind-down of carry trades used by investors to juice their bets than a hard and fast shift in the U.S. economic outlook, analysts say.

While Friday’s (August 2, 2024) weaker-than-expected U.S. jobs data was the catalyst for the market sell-off, with Japan’s blue-chip Nikkei index on Monday (August 5, 2024) suffering its biggest one-day rout since the 1987 Black Monday selloff, the employment report alone wasn’t weak enough to be the main driver of such violent moves, they added.

Instead, the answer likely lies in a further sharp position unwind of carry trades, where investors have borrowed money from economies with low interest rates such as Japan or Switzerland, to fund investments in higher-yielding assets elsewhere.

They have been caught out as the Japanese yen has rallied by more than 11% against the dollar from 38-year lows hit just a month ago.

“In our assessment a lot of this (market sell-off) has been down to position capitulation as a number of macro funds have been caught the wrong way around on a trade, and stops have been triggered, initially starting with FX and the Japanese yen,” said Mark Dowding, chief investment officer at BlueBay Asset Management, referring to pre-determined levels that trigger buying or selling.

“We don’t see evidence in data that’s saying we’re looking at a hard landing,” he added.

One Asian-based investor, who asked not to be identified, said that some of the biggest systematic hedge funds that trade in and out of stocks based on signals from algorithms started selling equities when last week’s surprise Bank of Japan (BoJ) rate hike sparked expectations for further tightening.