Market volatility has picked up markedly and we thought a written summary of recent events would be worthwhile.
There have been several key developments over the last few weeks that have culminated in higher volatility and nearly a-10% drawdown from recent market highs across global stock markets. Corrections like this happen from time to time – when they do, they are shocking and frightening, but are rarely times to panic. As most of us know, market corrections are not atypical.
Economic Indicators and Fed Actions
After several hotter than expected inflation reports in Q1, the Fed seemed likely to only cut rates once or twice this year. The June inflation report, however, showed our first month of negative inflation (price declines) since 2021. In conjunction with unemployment rising above key levels the last two months, the Fed chose not to cut interest rates at their meeting last Wednesday. The upward momentum of the unemployment rate over the last few months has accelerated to points that typically signal recession is ahead. A Fed Funds rate of 5.5% since July of 2023 has taken time to flow through the economy and dampen demand. Remember, slowing inflation was the Fed’s goal, and they have accomplished it. The question now is whether they kept their foot on the brake for too long. Growth in Q2 was still 2.8% annualized, a respectable number, but pockets of weakness are becoming more pronounced.
Historically speaking, the Fed has a poor record of anticipating trends in the economic data they watch. We wouldn’t be surprised to see an admission of this in the form of an emergency FOMC meeting and interest rate cut before the next scheduled meeting in September. On earnings calls, certain companies have indicated that when interest rates finally do fall, they expect earnings and revenues to pick back up. Since we are a consumer-based economy, this would be good for growth, ideally keeping employment at appropriately maximum levels and allowing the country and world to avoid a recession. Remember that after every contraction, an expansion follows, and markets have done very well since October 2022 despite the Fed’s aggressive hiking cycle to combat and reduce what was 9% inflation.
Global Influences and the JPY Carry Trade Unwind
While the Fed’s fight against inflation may be over, attention has turned towards the potential consequences of rate differentials across the world. Turn on CNBC today and you are unlikely to go more than 15 minutes without hearing the term “JPY Carry Trade”. For just the second time in 17 years, the Bank of Japan raised its benchmark rate, from a 0-0.1% range to 0.25%. A popular trade was borrowing Japanese Yen at lower interest rates, converting to US Dollars or other currencies and investing in higher yielding assets. With a surprise hike, the Japanese Yen is no longer free, the currency is strengthening, and this popular “carry trade” is now being unwound with haste.
Political Uncertainty and Market Implications
Further exacerbating volatility is the fact that we have far more uncertainty pertaining to our elections this November than after the Biden/Trump debate that took place on June 27th. After that night, markets began to price in a Trump victory. Love or hate Trump, the markets like certainty, so it wasn’t surprising that we saw a brief “Trump trade” rally. Fast-forward a month and Biden is out and Harris is gaining momentum in the polls, which is introducing fresh uncertainty to the market. In addition, heightened geopolitical concerns in the Middle East are adding to volatility, as there is very little clarity as how these tensions could evolve and their impact, both short term and long term.
Our Team is Actively Monitoring the Situation
All of this is to say – our portfolios are diversified and built to withstand exactly the kind of volatility we are seeing now. Regardless, diligence is paramount in times of stress, and we are always looking for opportunities with existing holdings or cash. If you would like to speak about any of the issues we touched on above, do not hesitate to reach out to your advisor.
