'the view': Looking back at August 2024

The view

Hello and welcome to the market view covering August. I’m Nathan Sweeney the CIO for Multi-Asset at Marlborough. This month's key themes were Japan carry trade, and the Jackson Hole Symposium.

Let’s start with the Carry Trade.

At the beginning of August Japan's stock market fell 12% in one day, its worst day in 37 years, only to rebound by10% the following day, clawing back nearly all the losses. The initial sell-off was attributed to the unwinding of the ‘carry trade’.

So, what is the carry trade?

Japan has had an interest rate of 0% for the better part of 25 years. This is not ideal for Japanese people, companies, insurance businesses, or pension funds looking to earn interest on their cash. This is precisely what gave rise to the yen/USD carry trade in the first place.

Simply put, the yen/USD carry trade is the act of borrowing money in yen from a bank in Japan for virtually no cost, as interest rates are so low, and putting that money to work somewhere where interest rates are higher, such as the US, where interest rates are 5.5%. Interestingly, if you walk into any Japanese bank, leaflets offer products that help you do just that.

So, what went wrong:

One of the risks you expose yourself to with the carry trade is the currency risk. If your currency (yen) strengthens, this will impact your returns. This was fine until the central bank of Japan raised interest rates (to 0.25%) for the first time since 2007, at the same time as the central bank in the US was considering rate cuts.

Some weaker unemployment data in the US (a weather-related blip, attributable to lower hiring due to poor weather, as they had a hurricane) increased investors’ expectations of quicker interest-rate cuts in the US. This caused the yen to strengthen rapidly against the dollar. So, investors unwound their carry trades as they were losing money on the currency side of things. Additionally, a stronger yen makes Japanese goods more expensive and consequently less attractive to potential overseas buyers. As a result, international investors have become cautious about Japanese corporate earnings, especially those of exporters such as automakers, so the market sold off too.

What happens next:

The carry trade will be less appealing with rising Japanese rates although very slowly, and falling US rates, not to mention the currency impact. However, the equity markets rebounded when they realised they overreacted, as US data is fine and US interest-rate cuts will likely be more gradual.

Takeaway:

to enjoy the long-term benefits of investing, you must withstand short-term losses. History has shown that those who chose to stay the course were rewarded for their patience

Now let’s look at the Jackson Hole Symposium

Simply put this is a conference for central bankers and economists in the town of Jackson Hole in Wyoming USA.

The anticipation of a Federal Reserve rate cut has been building, particularly following the recent Jackson Hole symposium where policymakers, including Fed Chair Jerome Powell, hinted at potential changes. Historically, markets have shown favourable reactions to rate cuts, but this cycle might differ from previous ones.

Why the Fed is Considering Cuts Now:

Unlike past rate-cutting cycles, which responded to economic downturns or financial crises, the Fed's current situation is unique. Inflation has cooled, with core CPI down to 3.2%—the lowest since April 2021. Meanwhile, unemployment remains relatively low, but there are signs of a softening labour market. The Fed appears poised to lower interest rates, not to accelerate the economy but they don’t need to keep rates so high because inflation is falling.

Market Implications of a Rate Cut:

Rate cuts generally provide a boost to financial markets. Stocks have historically performed well in the months following initial cuts, although the journey isn't always smooth. Investors can expect volatility, particularly as economic conditions shift and the market reacts to new data.

What's Different This Time:

This rate-cutting cycle is expected to be more gradual. Rather than large, crisis-driven cuts, the Fed may opt for smaller, 25-basis-point reductions. This cautious approach is in response to a complex mix of moderating inflation and still-strong employment figures. As a result, market rallies might not be as sharp as in previous cycles, but the ongoing adjustments should support a more sustainable path for growth.

Takeaway:

Overall, the market's reaction to a potential Fed rate cut is likely to be positive, especially if the cuts are seen as a move toward a balanced policy rather than a response to a crisis. Investors should be prepared for opportunities and challenges as the Fed navigates this new landscape.

We see opportunities in small caps and infrastructure as they are sensitive to interest rates and will likely benefit from interest rate cuts, which are areas we are reviewing. Anecdotally, through our single strategy funds, Marlborough has real strength in these areas.

Thanks for listening and join me next month on the view.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.

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