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Market sell-off: Key context

06 August 2024

Please note: All data referenced in this article are sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing. Past performance is never a guarantee of future performance.

As the saying goes, ‘When America sneezes, the world catches a cold’. But when America sneezes and Japan has a fever too, the world starts convulsing. This is what seems to have happened in recent days in financial markets.

Crucially, however, the current volatility doesn’t mean the end is nigh for investors. It might be uncomfortable to experience but it’s nothing we haven’t seen before, and we’d expect the famous resilience of the US economy – from where much of the recent angst derives – to come good over the longer term.  

News from the States

Underwhelming data releases from the US, and accusations that the US Federal Reserve (Fed) has been asleep at the wheel, have roiled markets.  

Last Friday’s employment data for July, known as the US nonfarm payrolls, showed fewer jobs were created than was expected (114,000 versus 175,000). This came alongside the highest weekly jobless claims in almost a year and decelerating US wage growth – currently 3.6% year-on-year, versus 3.9% in June. 

Wage and employment downturns are compounded by the news that US manufacturing is also weakening, and at a faster rate than was expected. The ISM manufacturing survey dropped to 46.8, below the prior consensus of 48.8. As a reminder, anything below 50 signals a contraction (and vice versa). 

In the space of around a month, US 2-year government bonds yields are down some 100 basis points (bp) and below 4% for the first time since Q2 2023. Meanwhile, the US 10-year is yielding just 3.8%. Markets are now pricing in a fed funds rate of around 4.1% by the end of the year, equivalent to four and half 25 basis points cuts.

Japan turns up the heat

While the US is the epicentre of the current global sell-off, events in Japan have also played their part. They serve as a further reminder of just how interconnected global markets and economies are.  

The Bank of Japan’s recent decision to hike interest rates, in the shadow of a strengthening yen, has gone against yen-carry trade investors (whereby a cheap and perceived-safe yen is borrowed and used to buy riskier global assets). The waning appeal of the currency, and the diminishing differential between US and Japanese rates, saw yen-carry traders rushing to unwind their bets, which in turn poured fuel on the sell-off fire being stoked by news from the US. 

A “growth scare” 

What we are witnessing across markets might be best summed up as a ‘growth scare’. 

The batch of underwhelming US data in recent days has spooked investors, many of whom had become accustomed to – and dare we say, complacent in the face of – the soaring trajectory of the US economy (you can read more about this in our recent article, ‘What’s happening to US stocks?’).  

While there’s no denying the US economy appears to be cooling, that in itself shouldn’t cause panic. At 4.3%, the US unemployment rate is far from being elevated by historical standards. And, if one looks closely, there were a couple of positives in last week’s job report: the higher participation rate (62.7%, up 10bp) and the modest improvement in goods-producing hiring (+25,000 versus +11,000 in June). 

In addition, the release of the services ISM on Monday has helped alleviate some recession fears. Indeed, the survey came in at 51.4 in July, higher than expected (51.0) and back into expansion territory.  

Not only that, but the employment component jumped from 46.1 to 51.1, suggesting that US services companies are hiring again. 

Déjà vu?

At the beginning of the year, markets were pricing in as much as six cuts by the Fed in 2024. Then, as the US economy continued to power ahead, pundits started to talk about possible hikes this year. Currently, money markets are pricing more than four interest rate cuts in the US. The pendulum we often refer to simply keeps on swinging. Today, the situation is a bit different though as the data releases in recent days, back up some of the market’s concerns.  

So, should investors be worried? Rather unhelpfully, the answer probably lies between ‘yes’ and ‘no’. 

  • Yes, because markets were (obviously) not positioned for a ‘growth scare’, and therefore some adjustment is to be expected in the face of the more uncertain outlook. There is also a question mark as to how far the unwind of the yen-carry trade has still to go.
  • But also no, because while we do expect US growth to slow, we don’t anticipate a collapse of the largest economy in the world. Markets should soon realise that. In addition, the diversification we’ve been advocating for should play its role as higher-quality bonds are providing some welcome positive performance in this risk-off environment (something that didn’t happen in 2022).

What’s next?

Trying to predict the future is a fool’s errand for investors but a general slowing of the US economy isn’t wholly unexpected, as we wrote in our Outlook 2024 report (see ‘Can the US economy keep defying gravity?’). The world’s biggest economy might be slowing, but it’s not collapsing. On aggregate, US companies’ earnings remain robust (around +10% year-on-year growth in Q2).  

It’s safe to assume that the next few days and weeks may be volatile, but crucially, this is exactly the type of situation diversified portfolios are designed to address. 

Maintaining composure is of the essence and investors should be mindful that potential investment opportunities may be on the horizon. It’s not all doom and gloom. 

In summary, the US economy has shown incredible resilience in recent years, and few would bet against that resilience playing a role in the months ahead. Things might feel daunting in the short term, but the long term is where the real value lies for investors.