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.
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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.
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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
