The United States is a relatively closed economy. Its exports and imports of goods and services as a proportion of economic output stood at just 27 per cent in 2022, one of the lowest shares among the world’s largest economies. US exports as a percentage of gross domestic product are even lower, standing at 11.6 per cent, according to data from the World Bank.
Yet when it comes to one particular kind of export – financial volatility – the US is punching well above its weight. While it stands to reason that the world’s biggest economy exerts strong influence over the rest of the world, it is supposed to be a safe haven. Not only is the US dollar the world’s dominant reserve currency, US Treasury bonds are the bedrock of the global financial system and the risk-free benchmark to price many other assets.
This makes the role of the US as a source of the turbulence in global markets this week all the more troubling. The Topix, one of Japan’s main stock market indices, fell a staggering 12.2 per cent on August 5, its steepest daily decline since the savage “Black Monday” sell-off in October 1987. The plunge, which was followed by a sharp bounceback the following day, dealt a severe blow to confidence in one of the world’s most popular equity markets.
While the Bank of Japan (BOJ) could not have picked a worse time to start raising interest rates, especially given how fragile the country’s economy is, the sell-off had more to do with what was happening on Wall Street. The rally in the US dollar stemming from the US Federal Reserve’s determination to keep borrowing costs higher for longer contributed to the collapse in the yen, eroding Japanese households’ purchasing power and heaping pressure on the BOJ to tighten policy to help shore up the currency.
However, the central bank’s decision last week to raise its benchmark rate to 0.25 per cent coincided with a weaker-than-expected US employment report. This heightened expectations that the Fed will soon begin cutting rates and accentuated the divergence between US and Japanese monetary policy.
All of a sudden, speculative bets on a further depreciation of the yen were rapidly unwound. The disorderly unravelling of the yen-funded “carry trade”, whereby investors borrow cheaply in yen to make higher-yielding investments elsewhere, amplified the volatility. This unleashed havoc on Japan’s stock market but inflicted more damage on one of the main beneficiaries of the carry trade: the “Magnificent Seven” group of giant US technology firms.
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Why investors can expect more market volatility after recent global stock sell-off
Why investors can expect more market volatility after recent global stock sell-off
Although tech-heavy Asian stock markets, such as South Korea and Taiwan, suffered heavy losses earlier this week, the overriding concern was the profit margins and outsize influence of the Magnificent Seven, whose combined market capitalisation would make the group the world’s second-largest national stock market after the US. The news last weekend that Warren Buffett’s conglomerate sold nearly half its stake in Apple, currently the most valuable company, was the last thing investors needed to hear.
The main catalyst for the rally in equity markets this year – the hype around generative artificial intelligence – has come under intense scrutiny. Many investors believe AI is overrated and will not be as transformative as its champions claim, at least not in the short term. Questions abound about “how much profit can be generated from the massive [capital expenditure] that’s going into the building of AI infrastructure,” HSBC noted.
Fears over US tech stocks are being fanned by increasing signs that the much-anticipated soft landing for the US economy will not be as soft as markets predicted. US economic data has come in below expectations in recent months, making investors more sensitive to the risk of a sharper slowdown.
A person enters an employment agency in Los Angeles on August 2. The US Labour Department reported that the American job market significantly slowed in July. Photo: EPA-EFE
On August 2, the publication of data showing a significant weakening of the labour market in July, with the unemployment rate rising for the fourth straight month, was taken as a sign that high borrowing costs were squeezing the economy. Sentiment, which was bleak to begin with, deteriorated dramatically. The narrative abruptly shifted from talk of “no landing” in the first quarter to “soft landing” in the second quarter to “hard landing” in the third quarter, TS Lombard noted.
Worries about a policy mistake by the Fed have proliferated. Bond investors are once again pricing in aggressive rate cuts, with a high probability of a reduction of half a percentage point next month. Not only is this fuelling volatility in markets, fears about a recession – which for the time being are overdone – risk becoming self-fulfilling.
In addition to being a main source of uncertainty about the global economy and markets, the US is the epicentre of political risk. While there are several reasons the Fed should avoid easing policy too sharply – a hefty rate cut would smack of panic, adding to fears about an imminent recession – the prospect of former US president Donald Trump returning to the White House strengthens the case for caution.
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Trump vows high tariffs on China-made cars in his first speech after assassination attempt
Trump vows high tariffs on China-made cars in his first speech after assassination attempt
Not only are Trump’s proposed policies inflationary, the Fed’s independence would be at risk if he wins a second term. Even if US Vice-President Kamala Harris wins the election, little effort is likely to be made to tackle the US public debt, long a crisis in the making.
The US is by no means the only source of volatility in the global economy. But the sheer size of its economy and capital markets, coupled with its safe haven status, make it the most worrying one.
