The market's daily fluctuations are unpredictable. After plunging on Monday, August 5, 2024, the S&P 500 bounced back the following day, August 6, 2024.
While investor anxiety remains, it has eased slightly. The VIX, a key measure of market volatility, spiked to 55.07 on August 5, reaching heights not seen since the early days of the COVID-19 pandemic (65.54 on March 27, 2020). Often referred to as the "fear index," the VIX dropped to 27.32 the next day, August 6.
The Federal Reserve's decision to maintain its high interest rates (5.50% and 5.25%) and disappointing U.S. employment and unemployment statistics, set the stage for a global market correction.
Yen carry trade unwinds
In an August 5 commentary, Capital.com, a UK-based digital trading platform with offices across Europe and Australia, questioned whether the Fed erred in keeping rates elevated.
Daniela Sabin Hathorn, Senior Market Analyst at Capital.com, noted that the Bank of Japan's rate hike last week led to the unwinding of some carry trades. This refers to the rush of investors borrowing low-interest yen (JPY) and converting them into U.S. dollars or euros to invest in global stocks.
“Many traders who were borrowing Yen at low interest rates, converted them to USD and used this to buy US stocks,” observes Sabin Hathorn. “But now, with higher rates in Japan, not only must they pay higher interest for the yen they borrowed, they are now facing forex losses as well.”
Impact on stocks
Hathorn believes the recent market moves have been slightly overextended, leading to a correction during the European session. However, the bias remains strongly to the downside in the short-term, she states.
“Traders will likely be paying close attention to the ISM data, a measure of US manufacturing activity, this afternoon (August 5) to look for any further signs of weakening, which could weigh further on the dollar and the stock market."
Tuesday, August 6, was a better day. Reuters observed that U.S. stocks closed sharply higher as investors returned to the market after Monday's massive sell-off.
Focus on the Fed
Reuters added that recent statements from Federal Reserve officials have eased fears of a U.S. recession. Attention is now turning to a likely rate cut by the Federal Reserve.
“The financial markets will be buoyed as the (U.S. presidential) race unfolds as well as by the Fed's behaviour in the coming months,” according to iA Global Asset Management's (iAGAM) August 2024 Monthly Macro & Strategy Bulletin.
According to the CME FedWatch tool, close to 60 per cent of interest rate market participants believe the Fed will cut rates by 50 basis points in its announcement on September 18, 2024. The remaining participants expect a 25 basis point reduction.
"The Fed is expected to start cutting rates in September, with three cuts likely this year," Sébastien Mc Mahon, Vice-President, Asset Allocation at iAGMA, and Chief Strategist, Senior Economist, and Portfolio Manager at iA Financial Group, told Insurance Portal.
He notes that U.S. GDP growth is gradually slowing to around 2 per cent, and the unemployment rate is rising slightly, driven by "increased participation (immigration) and temporary layoffs."
Stay aligned for the long term
In its monthly bulletin, iAGMA remains watchful of small caps, Big tech companies, the U.S. dollar, and high-tax companies. All of these asset classes are at risk of high volatility until the November election. "We believe the chances of an imminent recession are less than 50 per cent; our base case is a continued normalization of the U.S. economy," says Mc Mahon.
iAGMA's positioning remains relatively neutral. "We still like U.S. equities, but favor a rotation from technology to more defensive sectors that have been left behind. We also like cyclical sectors such as energy and materials, which benefit from attractive valuations and an acceleration in the global manufacturing cycle," explains Mc Mahon.
As for bonds, he notes that iAGMA entered this period with a slightly long duration. "We will consider adding more if signs of weakness materialize." He believes that the Fed's behavior and market liquidity generally outweigh the impact of U.S. elections. "We expect markets to lose interest in the presidential election for a few weeks," says Mc Mahon.
He advises investors to stay focused on their goals. "Investing is for the long term. Make sure your investments align with your risk tolerance and long-term goals, and avoid reacting abruptly to sudden market movements," advises Mc Mahon.
In the absence of a paradigm shift like COVID-19 or a financial crisis, rapid market movements are a good opportunity to put cash to work, he says.
