Baker Market Update
2024-08-09

Wow, what a week! This week’s volatility really began with last Friday’s weaker than expected employment report that saw the unemployment rate jump to 4.3%, the highest level in nearly 3 years and up 0.9% from the low in January 2023. That increase triggered the so-called Sahm Rule, which has a 100% accuracy of predicting recession since WWII. Wall street reacted by pricing in a 50bp rate cut in September and 100bp of cuts by year-end as there was a growing consensus that the Fed was behind the curve and needed to aggressively ease monetary policy soon. And that led to Monday’s action which saw the Japanese Nikkei crash 12% (equivalent to 4700 points on the Dow!) as traders unwound something called the “Yen Carry Trade.” The Yen Carry Trade is when traders borrow money in Japan at near zero interest rates and then use those funds to buy Japanese stocks or convert those funds from Yen to another currency like Dollars and then buy assets like US tech stocks or Bitcoin. As the Fed hiked rates from 2022-23 and the Bank of Japan left rates below zero, the trade worked perfectly as those borrowing costs remained low, the assets rose in value and the Yen depreciated. But then those tech stocks started to fall over the last month, the Bank of Japan raised interest rates above zero for the first time in a decade and the Yen appreciated as traders priced in big rate cuts from the Fed. Suddenly a very profitable trade was massively unprofitable, and traders rushed to unwind the carry trade, causing stocks to plunge in value and bonds to surge as investors sought safe havens. At one point on Monday, the 2yr yield fell to 3.65%, down 135bp since the end of May and the 10yr hit 3.66%. But once the worst of the Yen Carry Trade unwind was finished, the Nikkei and US stocks rebounded for the rest of the week and yields rose with the 2yr up 15bp to 4.03% and the 10yr up 14bp to 3.93%. The crisis has abated for now, but there is still believed to be trillions of dollars’ worth of Yen Carry Trades remaining, so the risk of more volatility in the future remains.

There was a lack of data this week, but next week is a full calendar. The focus will be on Wednesday’s CPI report to see whether inflation continues on its downward trajectory which would allow the Fed to deliver the big rate cuts the market now expect. We will also get retail sales, PPI, jobless claims, industrial production, housing starts, building permits, and University of Michigan sentiment so this could be another volatile week. Stay tuned!

Fed Funds Futures Rate Cut Probabilities