Stock markets experienced a significant downturn on Monday, with Japanese shares suffering a dramatic 13% decline. This sharp drop was triggered by growing fears that the United States could be heading towards a recession, prompting investors to flee from riskier assets and speculate that rapid rate cuts may be necessary to revive economic growth.
Safe-Haven Currencies Surge
The Japanese yen and Swiss franc surged as investors unwound crowded carry trades, forcing some to liquidate profitable positions to cover losses elsewhere. The massive selling pressure triggered circuit breakers across multiple Asian exchanges. Nasdaq futures plummeted 4.7%, while S&P 500 futures dropped 12.4%, indicating a global market rout. EUROSTOXX 50 futures fell by 2.1%, and FTSE futures declined 1.2%.
Nikkei Faces Unprecedented Losses
Japan’s Nikkei 225 index shed a staggering 13%, reaching its lowest level in seven months—a scale of loss not seen since the 2011 global financial crisis. The MSCI’s broadest index of Asia-Pacific shares outside Japan dropped 4.2%. In contrast, Chinese blue-chip stocks experienced a relatively modest decline of 0.5%, supported by a rebound in the Caixin services PMI, which rose to 52.1.
Bond Yields and Treasury Demand
Japanese 10-year bond yields fell sharply by 17 basis points to 0.785%, the lowest since April, as markets reassessed the likelihood of another rate hike from the Bank of Japan. In the U.S., Treasury bonds were in high demand, with 10-year yields dropping to 3.723%, the lowest since mid-2023. Two-year yields fell to 3.807%, having already decreased by 50 basis points last week, and could soon fall below 10-year yields, inverting the yield curve—a traditional recession indicator.
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Federal Reserve Rate Cut Speculation
The weak July payrolls report increased market expectations of a significant rate cut by the Federal Reserve. There is now a 78% chance that the Fed will cut rates in September by 50 basis points. Futures suggest 122 basis points of cuts in the current funds rate of 5.25-5.5% this year, with rates expected to drop to around 3.0% by the end of 2025.
Goldman Sachs analysts have increased their 12-month recession probability to 25%, citing the Federal Reserve’s capacity to ease policy as a mitigating factor. They now expect quarter-point cuts in September, November, and December. However, if August’s employment report is as weak as July’s, a 50-basis-point cut in September is likely.
JPMorgan analysts are even more pessimistic, assigning a 50% probability to a U.S. recession. They anticipate a 50-basis-point cut in September, followed by another in November, and suggest that an inter-meeting easing could be warranted if data deteriorate further, despite concerns about potential misinterpretation.
Seeking Safe Havens
Investors are closely watching the ISM non-manufacturing survey due later this week, hoping for a rebound to 51.0 after June’s unexpected drop to 48.8. This week’s earnings reports from companies like Caterpillar and Walt Disney will provide further insights into the state of the consumer and manufacturing sectors. Healthcare giants like Eli Lilly are also set to report.
Currency Markets and Safe-Haven Appeal
The significant drop in Treasury yields overshadowed the U.S. dollar’s usual safe-haven status, causing the currency to fall 0.4% against a basket of majors. The dollar also fell 2.2% against the Japanese yen to 143.10 and 1.9% against the euro to 156.35. The euro remained steady against the dollar at $1.0934. The Swiss franc benefited significantly from the risk aversion, with the dollar dropping 0.9% to hit a six-month low of 0.8485 francs.
Shifting Interest Rate Expectations
“The shift in expected interest rate differentials against the U.S. has outweighed the deterioration in risk sentiment,” said Jonas Goltermann, deputy chief markets economist at Capital Economics. He added that if the recession narrative takes hold, the dollar is expected to rebound as safe-haven demand dominates currency markets.
Commodity Markets Reaction
In commodity markets, gold rose to $2,456 an ounce due to its safe-haven appeal. Oil prices initially firmed amid concerns about escalating conflicts in the Middle East but were later dragged down by worries about global demand. Brent crude slipped 13 cents to $76.68 a barrel, while U.S. crude lost 22 cents to $73.30 per barrel.
The recent market turmoil underscores the delicate balance investors are trying to maintain as they navigate the uncertainties of a potential recession, fluctuating interest rates, and global economic instability.
