Photo: Michael M. Santiago/Getty Images
There has been a sudden and violent shift in the global markets. $6.5 trillion has been erased. Traders are calling it the Great Unwind, a reordering of the world’s capital flows as financial and geopolitical priorities — war, inflation, rising unemployment, recession — that all came to be questioned at once. On Monday, the world saw that change in real time, when the Dow Jones Industrial Average fell more than 1,000 points, the kind of drop that only comes during periods of intense economic fear and anxiety.
Then, there was calm. By the end of trading Tuesday, most markets had risen. The Dow Jones was up about 300 points. But it’s far from clear that steadiness will hold for very long.
August has a reputation for being a wild month in capital markets — a time when market participants tend to be on vacation, meaning there are fewer people to trade and prices swing more than they otherwise would. This end-of-summer volatility was directly connected to Japan’s biggest market crash since Black Monday in 1987. But a series of warning signs became apparent over the previous week that things were not quite right. Over the weekend, Warren Buffett revealed that he cut his share in Apple by about half and sold off more shares of Bank of America, one of the largest “too big to fail” banks. The intricate global financial latticework of cheap foreign money and strong domestic companies that’s propped up markets in a world facing pivotal wars and elections has, it appears, started to show cracks.
For nearly all of 2024, the mood among most investors alternated between frustration that economic growth wasn’t getting better faster and a near euphoria that the long, dour era of money-killing inflation was nearing its end. By Tuesday, as investors surveyed the reasons behind the crash, a consensus had started to emerge. The economy is not in free fall — not yet, anyway. The deep, structural issues that preceded the economic collapses of March 2020 of the Great Financial Crisis in 2008 are simply not present. This time, it does not appear that a big bank or hedge fund has gotten into serious trouble. Rather, most of the action appears to stem from many big investors unwinding a similar trade — borrowing in Japanese yen and investing in U.S. stock and other globally important assets — at the same time.
The damage, of course, is real. More than $1 trillion was erased from the seven largest U.S. companies on Monday alone. Crypto, a proxy for investors’ appetite for brainless risk, has plunged to a low not seen since the winter. These can have repercussions that will play out over weeks, if not months, as banks and hedge funds figure out how solvent they really are amid this unwinding.
At the moment, the odds of a recession have risen dramatically, as calculated by Goldman Sachs and other economists, and some of the baseline assumptions that have been propping up the global financial markets have vanished. Here’s what you need to know about this week’s sell-off and what it might mean for the economy.
The Dow Jones is often not a great proxy for broader Wall Street, since it just tracks 30 of the largest U.S. companies. But in this instance, it has been a good indicator to watch. After falling more than 1,000 points on Monday, it bounced up by 300 points on Tuesday — still down more than 5 percent from its peak, but a sign that traders were not convinced that the sky was falling.
Tuesday’s relative calm came after Japan, the epicenter of Monday’s stock-market rout, staged a massive comeback of its own. After its main index, the Nikkei, dropped more than 12 percent on Monday, it regained the majority of those losses the following day. Panic selling — essentially, a glut of traders all trying to sell their positions at once, leading to the fire-sale prices — is now seen as the cause of much of Monday’s carnage.
On Monday, the VIX, which is Wall Street’s so-called “fear gauge,” reached a level unseen since the early days of the 2020 pandemic. Bitcoin fell about 18 percent. Many tech stocks went into free fall, and the NASDAQ (where those shares tend to trade) fell 20 percent below its July highs. There was panic behind a lot of the selling — but there were also rational reasons to traders to run for the exits.
At least part of this larger decline has been driven by a massive rethinking of the tech-heavy, and artificial-intelligence-driven, bull market that has propelled capital markets this year. Nvidia — maker of the chips that power the AI industry — has lost more than $1.2 trillion in its market value in the past six weeks, when it reached its peak valuation of $3.5 trillion. (The chipmaker is also reportedly facing antitrust probes into its dominance in the industry and has recently faced productions snags on a next-generation chip.)
But it’s not just the wildly speculative world of cutting-edge technology. This weekend, when Buffett’s Berkshire Hathaway revealed that it was halving its stake in Apple — just about the most reliably profitable company in the world — the company also announced that it is sitting on a mind-boggling $277 billion in cash. Buffett is, of course, the most revered investor in the world, and someone whose decisions are studied, and copied, by his legions of fans. The implication here is that, if Buffett thought there was something worth investing in, he would be using that cash to make more money. By stockpiling all that money, he is sitting on the sidelines, which seems to indicate that the risks in the world are too high.
On Friday, new data dropped showing the unemployment rate in the U.S. rising to 4.3 percent, higher than expected. Historically, this is not a high reading, but what matters here is the speed at which the jobless rate has risen lately. In the past, a sudden spike in unemployment has indicated a recession is on its way. This observation is called the Sahm Rule — named for former Federal Reserve economist Claudia Sahm — and it is one of the key triggers economists look for in gauging the health of the economy. Last week, this gauge tipped over into pointing toward a recession.
Now, there are reasons to think the unemployment report looks worse than it actually is since those numbers reflect both higher-than-normal layoffs in temp jobs and an increase in people looking for work from higher immigration. Those details, coupled with an encouraging Monday manufacturing report, show “an economy in transition rather than one on the brink of collapse,” said Matthew Martin, an economist at Oxford Economics. It is simply too early to say if this means a recession will happen, and some of the most timeworn indicators of an economic downturn have been deeply wrong since the pandemic as the trillions of dollars of stimulus have seemingly dispensed with old assumptions about how the economy actually functions.
Still, there are “heightened recession fears,” said George Pavel, general manager at Capex.com. Goldman Sachs has upped the odds of a recession to about one in four.
Last week, at at its most recent monthly meeting, the Fed opted to keep interest rates steady, at about 5.3 percent, where they have been for a year. The decision was expected and left investors generally convinced that the central bank would start cutting interest rates in September — marking a key signal from the Fed that its fight against inflation is just about over. (Lower rates tend to stimulate the economy and investment.)
But keeping rates at their current, relatively high levels caused some alarm as well, as it has become clearer that the economy is weakening far faster than anticipated. To give you an idea of how rapidly the economy is weakening, I wrote exactly one month ago that if Fed chair Jerome Powell were to cut rates in September, there would be a slight risk that he would be moving too early. Now, Wall Street is convinced that would be far too late.
In isolation, the Fed’s decision not to cut wouldn’t have caused so much worry. But in combination with the bad unemployment report, which dropped two days later, it left markets spooked.
Then there was some surprising news from the Bank of Japan.
Most of the world’s major central banks are in the process of lowering, or preparing to lower, their interest rates, which they have held higher to stave off inflation. Not so with Japan. Last week, the Bank of Japan increased its benchmark rate by 0.25 percent and indicated that it would keep doing so in order to fight its own problems with inflation.
Japan has had seemingly intractable problems with its economy since the 1990s, including years of deflation that scared off investment. Most recently, its problem has been its currency, the yen.
One well-known feature of the global economy is that it is possible to borrow large sums of money cheaply — that is, at very low interest rates — in the Japanese currency. This allows a trader to take yen and then invest it somewhere else in the world (say, in U.S. markets) with a higher expected return. As long as there’s a significant difference between the lower-interest-rate yen and the higher returns of the investment, it is as close to free money as you can get.
This is called the carry trade, and last week — after many years — the Bank of Japan essentially blew it up. The yen fell from 160 to 143 per U.S. dollar, an extremely violent shift for a market that tends to move in fractions of a cent. As such, traders started to sell off assets they had purchased with those borrowed yen, sparking a global fire sale. “You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” said Kit Juckes, an economist at Société Générale, in a research note.
What comes next is still hard to see. Many economists think Monday’s sell-off was overdone, triggered by fear rather than a rational view that a recession would reasonably come. But there could be other problems that have yet to emerge. One key risk is that some hedge fund or bank got caught too late holding on to too-expensive yen or now-underwater Nvidia shares. If a large fund goes into bankruptcy, then all the others it owes money to could be next. “It is a question of who loaded up on tech at the wrong time,” one hedge-fund investor told me. “It’s early in the month, so it may take a few weeks to see real damage.”
This story has been updated.
