Market worries overdone

It’s been a volatile couple of weeks. That is the polite way of saying people have lost money in equities as we have seen market tumbles in Japan and in some US technology shares, leading to a general decline in markets. In recent days there has been a bit of a rally on reconsideration of the bad news.

The mini crash was started by a poor US manufacturing report and rising US unemployment figures, leading some to argue the US will go into recession. At the same time the rising yen on the back of the gradual shift of Japan away from zero interest rates led to a plunge in Japanese shares as some investors reappraised the implications of tighter money in Tokyo.

Intel reporting a small revenue fall and a move into loss helped upset the technology sector and led to fears other sector giants might struggle to maintain their recent stellar growth.

The US labour market

In April 2023, US unemployment was at a low of 3.4%. The economy was doing well generating plenty of jobs as the monies of the Biden Counter Inflation Act offset some of the impact of the Federal Reserve’s (Fed’s) higher interest rates. The unemployment rate drifted up to 4.1% by June this year. When July came in at 4.3%, with additional new jobs only at 114,000, for the month some in markets took fright. They thought this meant the Fed had run its high rates and tight money for too long and saw the weak employment numbers as a harbinger of recession.

The Fed policy committee in its June forecasts told us to expect 2.1% growth this year with 2% for both 2025 and 2026. It also expected unemployment this year to be in the 4-4.2% range. They anticipated bringing down the Fed funds interest rate from 5.1% this year to 3.1% by 2026 in gentle steps as the economy stabilised around 2% growth and 2% inflation. Had they got it wrong, the market asked last week?

Overall, the Fed dashboard shows a current successful picture, with inflation down to 2.5%, second quarter annualised GDP growth at 2.8% and unemployment 4.3%. The most recent growth figures showed consumers helping to move the economy ahead alongside more business investment. The International Monetary Fund (IMF) forecast 2.7% growth for the current year in the US.

Whilst the labour market is slowing this was part of the plan to get on top of nasty inflation. This seems to be working, which gives the Fead scope to cut rates in the last quarter of the year.

There is no reason to think the US will fall into recession next year given the relative strength of the economy, and every reason to suppose if data weakened further then there would be a more vigorous Fed response to administer stimulus.

The Fed has already abated the pace of its balance sheet reduction and has promised to end its run-off of bonds when it has reached a position of ample as opposed to abundant reserves. This gives it additional flexibility to keep markets liquid along with its reverse repo activities. It does not wish to precipitate a damaging market sell off and tightening of credit.

The US presidential election

As we remarked on the change of Democrat candidate, the arrival of Kamala Harris to replace Joe Biden has resulted in a much closer race with the Republicans. In recent polls Kamala Harris has pulled narrowly ahead of Donald Trump by 1-2%. She has narrowed the gap in swing states, making the outcomes particularly uncertain in Pennsylvania, Wisconsin and Michigan where she is narrowly ahead. She needs to establish leads in the others to keep the momentum going.

The Democrats have managed to inject more vigour and support into their campaign which was always based around claiming Donald Trump was unsuited for office by virtue of his attitudes and past conduct. The Democrats prefer to talk about their opponent than the issues, whilst highlighting their stance on abortion.

Kamala Harris says little on her website about the policy offer, talking of “doors of opportunity wide open for all to follow”. She defends the Biden/Harris record in office on the economy pointing to the success in generating more jobs.

The Republican campaign seemed concerned about the switch of candidate by the Democrats though they had been very critical of Biden’s age and performances. They are sticking with their 20 policy proposals set out on their campaign website. These include sealing the border, making the US the dominant energy producer in the world and large tax cuts for workers. They state there will be no cuts in social security or Medicare though their opponents allege they would cut them.

The outcome on the economy will be an important influence on voters. Donald Trump has warned of worse to come on jobs, the stock market and the economy from current policies, whilst the Democrats point to past job growth with inflation coming down.

If more voters lose their jobs or find it more difficult to get one, that will help Mr Trump. If there is the soft landing we have seen so far, it makes it a more even contest. Kamala Harris must live with the inflation of the Biden years and with the attacks on her lack of control over borders. Donald Trump must fend off more criticisms of his remarks and past conduct, with a more difficult opponent to defeat without looking like a bully.

The sudden rise of the yen

For some time, global investors have relied on a falling yen. Some have borrowed in yen thanks to the very low interest rates to buy assets offering a better yield, whilst others have shorted the currency for profit. You got just over yen 100 for a dollar early in 2021, 147 yen for a dollar by October 2022 and 161 yen this June. There has been a sharp rally in yen taking it to 147 to the dollar and causing painful losses to some traders expecting a further fall.

It seems likely the Japanese authorities will seek to edge interest rates up further. This reduces the supply of cheap loans to buy financial assets and makes Japanese companies trading abroad a bit less competitive as the currency rises.

Recent severe movements imply too many speculators had positions they could not afford to continue as soon as the yen started to climb. They will have learned a dear lesson, leading to lower volatility as the extreme solutions are closed. There are limits as to how far the Bank of Japan dares go with raising rates, given the massively overextended position it and the Japanese government have with their own bond portfolios, and given the importance of cheap or free borrowing to the Japanese state budget. We will be monitoring this carefully as their policy evolves.

The August squall in markets was overdone, reflecting low general volumes and overextended positions against the yen. We had been expecting a broadening out of markets from their reliance on US technology leaders.

We had said that the technology stocks now needed to deliver great figures to justify ratings and that some would disappoint and experience severe reappraisals as happened with Intel and Tesla on the back of poor figures.

The Fed can loosen policy quickly if there is further deterioration in the US economy and employment prospects and will doubtless do so. Japan has taken small steps so far to normalise its monetary policy but has already changed the way markets look at the yen which means less cheap yen around to borrow and less certainty over profits from shorting the currency.