Monday morning saw global stock exchanges awash in red. Weak economic data from the U.S. heightened fears of an economic downturn, leading to last week’s sell-off of risky assets. The market crash intensified at the start of this week as investors withdrew money from falling stocks and cryptocurrencies. In this environment, demand surged for safe-haven assets such as U.S. government bonds, the Japanese yen, and the Swiss franc.
Last week, we saw a significant strengthening of the yen against the dollar. This trend continued into the start of this week. At the end of July, two major central banks, the Bank of Japan and the Federal Reserve, held meetings on the same day. The Bank of Japan tightened its monetary policy by raising the rate by 0.15% (above expectations) and announced a halving of its monthly government bond purchases. This led to the yen strengthening by more than 4% last week and an additional 2.6% at the start of this week.
Market Reactions to Anticipated Fed Rate Cut
Meanwhile, market participants speculated that the Fed would likely cut its key rate in September. Late last week, this caused U.S. government bond yields to fall and narrowed the yield gap between Japanese and U.S. government bonds. Speculative money exited short positions on the Japanese currency, sharply strengthening the yen. This negatively impacted Japanese exporters’ stocks, triggering a major sell-off on the Japanese stock market (the Nikkei-225 index plunged 12% today, marking its largest one-day drop since October 1987). Risk aversion led to increased selling on global stock exchanges, falling commodity prices, and a drop in oil prices.
What’s Next?
Everyone is wondering what to expect next. The VIX index jumped to 37 at the start of this week, about three times higher than its mid-July level of 13. At the same time, the Nasdaq-100, which includes leading tech giants with the largest market capitalizations, fell nearly 17% from its July highs. The yen, as a safe-haven asset, strengthened by 12%, while the dollar index weakened by 2.5% over the same period.
Historical Market Behavior
Let’s look at how markets have behaved during similar dynamics in the past. The last sharp rise in the volatility index was in March 2020 — during the height of the global pandemic when many economies went into lockdown. The VIX then soared to 80, the Nasdaq index plummeted 30%, the yen surged 10%, and the dollar weakened locally by 4.5%. The scale of the problems then and now is different. Since spring 2020, during local corrections, the VIX rise did not exceed 38, and periods of high instability generally lasted no more than two weeks.
In this context, this week could be decisive for global currency and stock markets. We might see either a local risk-off or the beginning of a new medium-term trend. Notably, savvy investor Warren Buffett increased his cash holdings at the end of the second quarter — a key rule in all crises. Berkshire Hathaway’s cash reserves reached a record $277 billion after the billionaire investor sold off $76 billion worth of Apple shares.
A strong surge in the VIX index has often accompanied shocks beyond stock markets. A threefold increase in the VIX occurred during the 2011 European debt crisis, and a fivefold spike coincided with the 2008 and 2020 crises.
Possible Regulatory Intervention
There are rumors in the financial media that the Fed might hold an emergency meeting early this week following the major correction in the Japanese stock markets. This significant event could profoundly impact global financial markets.
Therefore, buying falling assets is not the best strategy for inexperienced investors during a market crash. It’s better to wait until the falling knife lands and stops trembling.