Investors looking to pin the blame for the sudden panic in markets might wonder whether US chip firm Intel’s (INTC:NASDAQ) decision to lay off staff and cut spending, triggering a 26% fall in the share price on 2 August, was the trigger for the broad sell-off.

While Intel may have played a part, the root cause of the market’s current malaise is the unwinding of the ‘carry trade’ involving the Japanese yen.

Since the start of 2021, global investors have been borrowing money in yen at rock-bottom interest rates and reinvesting that money in riskier, higher-yielding assets including technology and AI (artificial intelligence) stocks.

Over the last three and a half years the yen has steadily weakened from around Y100 to the dollar to Y160 meaning investors have made money on both sides of the trade – not only have tech stocks, among other riskier assets, done phenomenally well for them, but their cost of funding has got cheaper.

However, with little advance warning this trade hit the buffers last month and in the last three weeks the yen has appreciated by more than 10% to less than Y143 to the dollar.

A combination of the Bank of Japan raising interest rates to fight off inflation, which has supported the yen, and the US Federal Reserve’s refusal to ease monetary policy despite the growing evidence of a slowdown in the labour market, has stoked fears a global recession could be in the making.

The net result is traders have reversed their ‘carry’ trade, closing their short yen positions and taking off their riskier bets.

That has had the effect of undermining the most consensus trades, which as well as US tech stocks include the Japanese market and the highest-risk assets of all, cryptocurrencies.

On 5 August, the Japanese Nikkei 225 index plummeted 13% marking its worst one-day performance in 37 years, while other Asian markets such as Taiwan – which is heavily-weighted towards tech stocks – also fell heavily.

These sharp downward movements in prices are contributing to what is known as ‘forced selling’, where some investors – especially those who trade ‘on margin’ or use futures and options – suddenly have to ditch their holdings and raise cash to cover their losses.

This leads in turn to more selling pressure in an already-weak market, which can give rise to ‘panic-selling’, where investors just want to get out to the market altogether to avoid losses.

This kind of volatility is perfectly normal, and in time markets will settle down, so while the temptation to hit the sell button is strong the smart thing to do may actually be to do nothing. 

‹ Previous2024-08-08Next ›