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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
I try to use my precious space in a national newspaper to demystify financial markets and encourage investors, amateur or professional, to understand where the key risks and opportunities lie.
Within that brief, the powerful ascent of stock markets, led by the US, has been the most notable feature of recent years, decades even. And yet not once while stocks have powered ahead have I ever pointed to the scary and serious sounding yen carry trade as a key factor behind the trend.
The use of yen — borrowed cheaply because of the Bank of Japan’s rock-bottom interest rates — to buy US equities has simply never made the list as a crucial pillar to markets. The US big tech miracle, the explosion in retail trading and index-tracking funds, the ins and outs of US interest rates — all these are well-trodden themes, but the yen carry trade has never featured.
Now, however, the yen carry trade is faltering. The super cheap yen is no longer quite so super cheap, after the BoJ bumped up its interest rates for only the second time in 17 years. Suddenly this is the topic of the day, identified far and wide as one of the key reasons why global stocks suffered a summertime shakeout while I was sitting on a Turkish sunlounger sipping delightful iced palomas.
Do I owe you an apology for failing to spot the role that BoJ policy was playing across the world’s developed markets, for missing this pressing global financial stability risk? Not to deflect the blame, but not one asset manager, sharp-suited strategist at an investment bank or wonky policy nerd ever pointed to it as a reason why global stocks were sailing higher before they began to stumble. Are we all guilty of the same siloed thinking and inability to connect the dots that led the global economy to disaster in 2008? I don’t think so.
Instead, we are witnessing an elaborate game of pin the tail on the donkey, with blindfolded people paid to articulate clever reasons for every wobble in every asset class struggling to explain why markets took a tumble. Japanese stocks dropped 12 per cent in a day, and US markets suffered a very testing week only for most of these moves to reverse almost entirely by the time I had hauled myself off the sunlounger and back to my desk. (Sigh.) Surely there’s a sinister or complicated reason for all this?
The reality for those of us wondering what next after those panicky summer days is that the episode changes very little, but does suggest asset prices might not have been in the right place to begin with. We are going to have to get used to ugly spikes in volatility like this.
The performance of the yen and of stocks are indirectly connected, as I have noted before. High US interest rates support the dollar, particularly against the Japanese currency where rates, though rising, are still close to zero. A US recession, if it ever landed, would suggest a blow to corporate earnings, and therefore to stocks, as well as dragging down the buck and fluffing up the yen. “They are correlated,” Johanna Kyrklund, Schroders Group chief investment officer, told me at the end of July when the first tremors of the market turmoil started. “Fundamentally they both have the same root.”
But, she added, the synchronised dive in the dollar against the yen, and in stocks, were really no more than a “technical summer thing” and an opportunity to “blow a bit of the froth off the market”.
That is the key here. Investors were looking for an excuse to tap the brakes. Pearl-clutching about the yen carry trade fitted the bill perfectly. It is real — Japanese investors fleeing US stocks and bringing their yen back home is a genuine phenomenon that amplified declines on the margins. But it is hard to argue this is a plausible principal reason for global stocks to drop 6 per cent in just a few days.
Vickie Chang, an analyst at Goldman Sachs, suggests that yes, the market did go too far, not during the shakeout, but before it.
“It is possible that the market had already overshot . . . become too optimistic on growth before the recent growth scare,” she wrote in a note to clients this week. “We find some evidence that may have been the case . . . Part of the reason for the abruptness of the shifts is that the market may have had some ‘catching down’ to do.”
Signs of weakness in the US jobs market and a clear moderation in US inflation provided the trigger for investors to make that move. Japanese currency gyrations are a symptom rather than a cause of the same thing.
The glue holding the weak yen and upbeat global stocks together is the consensus in markets that the US economy will execute a perfect landing, slowing down gracefully rather than with a painful recession. More recent US economic data, notably robust retail sales, suggest that remains the right bet.
But the summertime flirtation with doom is a warning to proceed with caution. When every major asset class in the world hinges on a US soft landing, the exits are crowded when doubt sets in. Investors are clearly in the mood for using any excuse to lock in gains and take a step back.
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