What’s Driving Olympic-Sized Market Volatility?

Surprisingly, the Paris Olympics has a stiff competitor in the excitement department this week: the U.S. economy and markets. Investors have faced sharp selloffs, wild swings, and a surge in volatility. It all started with disappointing jobs data and was exacerbated by a series of complex factors, from the unwinding of the yen carry trade to the lingering effects of Hurricane Beryl. Speculation about potential interest rate cuts and rising recession fears have added to the uncertainty. There’s no shortage of opinions on what’s driving market fluctuations and what they might mean for the future. Here’s what we’re tracking at the moment. 

Carry on? The carry trade, a strategy where investors borrow money in a country with low interest rates (like Japan) and invest it in higher-yield assets elsewhere, seems to be at the heart of recent turmoil. The yen’s value spiked when the Bank of Japan hiked rates, making it more expensive to repay yen-based loans. “You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” said Kit Juckes of Societe Generale. Although the yen was down later in the week from its earlier highs, the situation is far from resolved, with some believing it also signals a potential tightening of global credit conditions, which could increase U.S. recession risks. 

Blame it on the rain? Ed Yardeni, a well-known economist, attributes the recent stock market turmoil partly to weather-related disruptions caused by Hurricane Beryl. Despite the Bureau of Labor Statistics stating that the hurricane had no discernible effect, Yardeni highlights that 1.54 million workers were either not working or working part-time due to weather in July, up significantly from June. “The labor market isn’t weakening; it’s just normalizing,” said Yardeni, suggesting that the market overreacted to the weather-impacted jobs report. 

How low will they go? Investors are betting that the Federal Reserve will implement significant interest rate cuts to stave off a potential recession. Traders expect a half-point cut in September, followed by further easing, which could reduce rates by 2.25 percentage points by the end of next year. “No recession today, but one is increasingly inevitable by year-end if the Fed fails to act,” said Steve Blitz, chief U.S. economist at TS Lombard. Even before the steep drop in markets, some were wondering if the Fed had already waited too long.  

Is consumer spending key? Recent signs of cautious consumer behavior, such as increased price sensitivity and a shift towards lower-cost items, could indicate a slowdown in spending, which may affect overall economic growth. If consumer spending weakens further due to rising credit card delinquencies and shrinking household savings, it could lead to revenue declines for businesses and potentially precipitate job losses, creating a negative economic cycle.