Higher Japanese rates, US concerns and AI doubts batter global stocks

The International Monetary Fund and central banks are among those that issue financial stability reports that point out threats to financial well-being.

In a few weeks over 2023, the European Central Bank¹, the IMF²and the Reserve Bank of Australia³ issued their respective reports on the multiple threats to financial tranquility. What was noted by many was they all included the menace posed by a tightening in Japan’s ultra-loose monetary policy.

As a guide to how loose has been Japanese monetary policy, the Bank of Japan in 1999 pioneered zero benchmark interest rates, in 2001 the bank invented quantitative easing, and in 2016 the bank implemented negative interest rates and conceived a policy of ‘yield-curve control’ where it aimed to keep the 10-year government bond yield at 0 per cent

The ECB, IMF and RBA said they were concerned that higher Japanese interest rates would alter the capital flows that surround the world’s biggest creditor nation. They pinpointed two ways this could pose a threat.

One was that higher local rates would prompt the Japanese to repatriate enough of the US$3.8 trillion Bloomberg calculates they hold in foreign investments to shake the global financial system⁴.

The other threat was a diminishing of the ‘yen carry trade’. This term describes how investors have exploited a weak yen and Japan’s super-loose monetary policy. What investors – more speculators – have done is borrow at low rates in yen, convert the money to other major currencies and then invest these sums in securities such as US bonds and stocks that offer higher returns than the cost of the debt. The carry trade would always go wrong if Japanese rates and the yen rose.

Concerns about the threat of higher Japanese rates came to pass on July 31 when the Bank of Japan unexpectedly tightened monetary policy, this time by raising its benchmark rate from about 0.1 per cent to about 0.25 per cent.

The decision boosted the yen which hurt Japanese export stocks so much the Tokyo Stock Exchange on August 5 plunged 12 per cent, its biggest decline since 1987.

But the global tumble in stocks is not all due to Japan. Another source of uncertainty is the outlook for the US economy. An employment report on Friday, August 2 showed employers hired a fewer-than-expected 114,000 workers in July, while the unemployment rate that month rose to 4.3 per cent, a three-year high⁵.

Bit technical but the jump in the jobless rate stirred concerns because it fulfilled the ‘Sahm rule’, according to its begetter former Fed economist Claudia Sahn⁶. This rule says the US economy is already in a recession once the three-month average of the unemployment rate rises at least a half percentage point above its low in the past 12 months.

The S&P 500 Index fell 1.8 per cent the day the jobs report was released and extended these losses by 3 per cent on Monday, August 5 amid concerns the report added to evidence the Federal Reserve has overestimated the vitality of the US economy and delayed needed rate cuts.

On July 31, the Fed’s policy-board members met and disappointed many when they left the US cash rate at a 23-year high of 5.25 per cent to 5.50 per cent⁷. Futures markets are now pricing in three rates cut by year end⁸.

The other reason why global stocks are turbulent relates to the biggest US technology stocks. The US stock market this year has surged to record high after record high on a belief that advancements in artificial intelligence will fuel vast productivity gains. This euphoria bordering on hype boosted all stocks related to AI, most notably Nvidia, a supplier of AI hardware and software.

But recent earnings results from some of these stocks disappointed investors who are now less besotted by AI’s potential and are demanding returns on investments in AI.

To be sure, there are other reasons for the recent sell-off. One is that Warren Buffet’s revered Berkshire Hathaway on Saturday, August 3 reported it sold a net US$75.5 billion worth of stock in the June quarter, including halving its holding in Apple⁹. Another trigger is the jump in tensions in the Middle East.

The numbers of credible causes behind the recent swoon in stocks makes it hard to predict where stocks will head though it’s notable that many markets have already staged partial rebounds.

What’s an investor to do amid such uncertainty? Stocks are well ahead so far in 2024 and the best advice is probably not to panic. A more important point to grasp is that any uncertainty once again highlights the benefits of diversification across the major asset classes of alternatives, bonds, cash, stocks and property.

Atrium is a multi-asset investment manager that grows wealth for clients with our Risk Targeted investment approach. We are experts in understanding opportunity and managing risk – we build portfolios with an aim to outperform a benchmark or to achieve positive returns.

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¹European Central Bank. ‘Financial Stability Review, May 2023.’ Section 2.3 31 May 2023. ecb.europa.eu/pub/financial-stability/fsr/html/ecb.fsr202305~65f8cb74d7.en.html#toc2

² IMF. Global financial stability report. ‘Box 1.4.1. Potential spillover effects of changes to Japan’s yield curve control policy.’ April 2023. Page 52. imf.org/en/Publications/GFSR/Issues/2023/04/11/global-financial-stability-report-april-2023

³Reserve Bank of Australia. ‘Financial stability report.’ April 2023. Page 8. rba.gov.au/publications/fsr/2023/apr/pdf/financial-stability-review-2023-04.pdf

⁴Bloomberg News. The Big Take. ‘A US$3 trillion threat to global financial markets looms in Japan.’ 30 March 2023. bloomberg.com/news/articles/2023-03-30/boj-s-ueda-could-shake-global-financial-markets-by-changing-kuroda-policy

⁵US Bureau of Labor Statistics. ‘The employment situation – July 2024. bls.gov/news.release/empsit.nr0.htm

⁶Sahm says’Sahm Rule’ was triggered after jobs report.’ Bloomberg. 3 August 2024. bloomberg.com/news/videos/2024-08-02/sahm-says-sahm-rule-was-triggered-after-jobs-report

⁷‘Federal Reserve issues FOMC statement.’ Federal Reserve. 31 July 2024. federalreserve.gov/newsevents/pressreleases/monetary20240731a.htm

⁸CME FedWatch Tool. On August 7 US time, for instance, the gauge gave a Fed rate cut a 74.5 per cent probably in September. cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

⁹‘Berkshire cuts Apple stake by almost half in selling spree.’ Bloomberg News. 3 August 2024. bloomberg.com/news/articles/2024-08-03/berkshire-hathaway-s-cash-pile-soars-to-record-276-9-billion