Over the past few months, major central banks have reached their respective inflection points in their monetary policies and begun shifting towards rate reduction policies. As global economies show signs of cooling inflation and a slowdown, central banks have moved their focus to easing monetary policies. The Swiss National Bank was the first to lower its benchmark interest rate in March. In June, the European Central Bank (ECB) followed, reducing its key interest rate by 0.25% for the first time in five years. Other central banks, including the Bank of Canada and the Bank of England (BOE), also lowered interest rates, with the BOE reducing rates by 0.25%, to 5%, marking its first cut in four years.
Conversely, earlier this year, the Bank of Japan (BOJ) abandoned its negative rate policy and raised its benchmark interest rate by 0.25% last week, from its previous level of 0%-0.1%.
Focusing on the US, the Federal Reserve (Fed) has been slower to adopt an easing policy, as expected. After the last FOMC meeting, Chairman Powell indicated that the committee believes the economy is nearing the point where it will be appropriate to reduce the policy rate, potentially as soon as the next meeting in September.
Last Friday’s release of US monthly unemployment figures, for July, caused a significant shift in market sentiment. The unemployment rate unexpectedly rose by 0.2%, from 4.1% to 4.3%, the highest level since 2021. Additionally, non-farm payroll figures were much lower than anticipated, with only 114,000 jobs added compared to the expected 175,000-190,000. The Fed’s aim for a “soft landing” after a period of inflation has always been to manage the transition from rate hikes to rate cuts, while pursuing its “dual mandate” goals of maximum employment and 2% consumer inflation.
The jobs report had an immediate negative impact on global equity markets. Investors are questioning whether the Fed is now behind the curve in lowering interest rates quickly enough to avoid a “hard landing” and a potential recession. From July 31st to midday August 6th, the Dow (DJIA) and S&P 500 declined by more than 5%, while the Nasdaq Composite fell by over 7.5%.
On August 5th, Japan’s Nikkei experienced its largest single-day decline of -12.4% since 1987, driven by concerns about the US economy and the recent appreciation of the Japanese Yen (JPY) against the US Dollar (USD), due to rising Japanese interest rates. With the BOJ’s recent 0.25% rate hike and anticipated US rate cuts in September, by 0.25%-0.50%, the interest rate gap between the two countries has tightened, and this trend is anticipated to continue.
The appreciation of JPY has also led to the unwinding of long-standing JPY carry trades, adding to USDJPY decline. Global investors have been borrowing JPY at low interest rates to invest in higher-yielding assets. As the value of JPY rises and the BOJ raises rates, the carry trades are being reversed, resulting in JPY buying due to increased margin calls on the borrowed currency.
To illustrate the decline in USDJPY over the past few weeks, below is a USDJPY spot FX graph (July 9th – August 6th), showing significant JPY appreciation against USD, using market data price points from TraditionData. During this period, USDJPY hit an intraday high of ~161.70 on July 10th and an intraday low of ~141.90 on August 5th, representing a ~12.25% decline over the month.
“The upcoming US Presidential Election, ongoing geopolitical tensions in the Middle East and Ukraine, and central banks’ monetary policy decisions addressing changing economic conditions – these are all factors expected to add to global capital markets volatility for the remainder of 2024.” Sal Provenzano, FX Product Manager.