FTSE 100 tumbles as US recession fears spark global market selloff, as Japan’s Nikkei suffers worst losses since 1987 – business live

Saxo’s chief investment strategist, Peter Garnry, identifies five factors behind the stock market selloff:

1. Recession fear as the “Sahm Rule” is triggered. The “Sahm Rule” is triggered when the 3-month average US unemployment rate is up more than 0.5% from its low over the previous 12 months. This indicator has correctly identified every recession since WWII, so its triggering on Friday planted the seeds of recession fear that led to declines in equities.

2. AI profit taking after massive bull market. The AI and semiconductor theme had been one of the strongest themes over the past year. When there is a turnaround in sentiment the pockets with the most momentum are always hit the most.

3. Japan’s surprise rate hike upsetting funding markets. The Japanese central bank has kept its policy rate much lower than any other central bank throughout this entire cycle causing the Japanese yen (JPY) to consistently decline. As a result JPY has been a key funding current for leverage in financial markets. The central bank’s surprise decision to hike the policy rate last week while making hawkish comments have caused turmoil in JPY and funding markets.

4. 1-day options and the “divergence trade”. The US options market has become enormous and especially the 1-day options market has become a dominant force. In addition, Wall Street has been playing an options game called “divergence trade” which involved selling VIX futures and buying call options on technology stocks. When the VIX Index explodes higher this trade has to be unwound quickly. It adds to the volatility and increases market moves.

5. Historical equity market concentration. We have written a lot about this topic. In late June the US equity market reached its highest market concentration since the 1930s meaning that the equity market weighting is dominated by a small group of stocks. This increases the risk in the equity market because the diversification is lower and thus more fragile to a change in sentiment as we have seen today.

The dominant theme in the markets is the unwinding of various carry trades in currencies such as the yen, says Fawad Razaqzada, market analyst at City Index and FOREX.com.

As flagged earlier, “carry trade” is a strategy where traders borrow money at low-interest rates and invest it in higher-yielding assets. It worked well for Japan’s yen, untill the BoJ raised interest rates last week.

Razaqzada says:

It’s been a rough ride for global risk assets lately, and the turbulence shows no sign of easing at the start of this week. Investors are gripped by fears that the Federal Reserve has waited too long to pivot on its policy, especially in light of Friday’s disappointing US jobs data and a slew of other weak economic indicators pointing toward a looming recession.

It appears as though Friday’s soft jobs report was a game-changer for US rates markets. Short-term US yields took a nosedive as the market consensus shifted dramatically, now expecting the Fed to slash rates significantly this year. We’re talking about a massive shift: the market is now pricing in around 120 basis points of Fed rate cuts before year-end, all driven by recession fears. No more hoping for a smooth, orderly adjustment in Fed policy. In fact, investors are now bracing for a 50-basis point cut in September, double the 25 basis points they were anticipating before.

Falling bond yields have flipped the script on low-yielding currencies. After a tough first half of the year, these currencies are now on the rise. With the Fed and other major central banks expected to lower interest rates, the US dollar and other high-beta currencies are being dumped in favour of the Japanese yen, Swiss franc, and Chinese renminbi. The yen, in particular, is getting an extra boost from last week’s hawkish BOJ rate decision, adding to its newfound strength.

Time for a quick catch-up, after around three hours of trading in London.

• Global stock markets are in retreat today as the selloff which began last week, sparked by fears of a US recession, accelerates.

• Japan’s stock market has posted its biggest one-day drop since 1987, with the Nikkei plunging over 12% today.

• The Yen has strenthened to a seven-month high, as investors continue to react to last weeks’s surprise rise in Japanese interest rates. That has hurt investors who were involved in the yen carry trade – borrowing the yen cheaply, to buy other higher-yielding assets.

• European stock markets are all in the red. The UK’s FTSE 100 index is currenty down almost 2%, or -196 points, at 8014 points, having hit its lowest level since April this morning.
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• Across the Channel, France’s CAC is down 2.3%, while Germany’s DAX has lost 2.7% and Italy’s FTSE MIB is down 2.8%. Banks and tech stocks are among the major fallers in Europe.

• Wall Street is heading for another bath, with the Dow Jones industrial average set to fall around 1.6%.

US investors have been unsettled by weak economic data, such as last Friday’s drop in job creation.

Samer Hasn, senior market analyst at XS.com, says:

The collapse comes amid concerns about the health of the US economy after Friday’s shocking data, coupled with the uncertainty created by poor earnings season and heightened geopolitical tensions in the Middle East.

The extremely negative non-farm payroll figures sparked a wave of concern about the possibility of achieving a hard landing in light of rising interest rates.

Just in: the eurozone economy stalled in July as demand for goods and services deteriorated.

That’s according to the latest poll of purchasing managers, by data firm S&P Global.

It’s eurozone Composite PMI Output Index has fallen to a five-month low of 50.2, a level which shows activity barely rose last month (50 is the cut-off between expansion and contraction).

Growth in the services sector slowed, with companies reporting a weakening in new business.

Dr. Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank, says:

“The eurozone’s economy is growing at a snail’s pace in July. Sector-wise, services is not picking up speed like it did earlier in the year, while the industrial slump has continued unabated. Because of this, the HCOB Composite Output PMI is just hovering above the expansion line.

So, while the second half of the year started off pretty weak, the PMIs and the official numbers for economic growth in the second quarter were surprisingly good. Given this situation, our 0.7% growth forecast for the year is still conservative. “You cannot miss the slowdown in the service sector. The PMI has dropped for three months straight to 51.9, companies have been more hesitant about hiring, and new business is barely ticking up.

The extraordinary effects from the European Football Championships in Germany, the Olympics in France, and Taylor Swift’s concert tour in Europe are winding down too. So, the service sector probably won’t give us much of a boost in the second half of the year.