As the Reserve Bank’s board members will have heard from staff yesterday and again today, there’s no danger of the US economy falling into recession — despite what the headless chickens in the markets might be claiming.
The data that is being blamed for the big US sharemarket sell-off — a weak reading on American manufacturing activity and a weak jobs report for July — were normal variables in the world’s biggest economy. The activity survey for US manufacturing did contract for a fourth month in July to a reading of 46.8 — but manufacturing, despite the efforts of Donald Trump and particularly Joe Biden to expand it, still only accounts for just over 10% of America’s economy. The US economy, like most Western economies, is dominated by services. The services sector survey released overnight showed the huge US services sector bouncing back from a low of 48.8 in June to a strong 51.4 in July, above forecasts.
In fact the business activity sub-index saw a surge to a boom-like 54.5 from a reading of just over 49 in June. That confirms that the US economy is chugging along nicely, whatever the chooks might say.
So why the big Wall St sell-off? The answer’s simple: the yen carry trade. That’s where investors borrow at ultra-low interest rates in Japan — where interest rates have been negative since 2007 — to invest elsewhere in sharemarket giants like Nvidia or Apple, or even our own Commonwealth Bank.
That was a great strategy even after the Bank of Japan (BoJ) lifted rates to 0-0.1% in March, ending 17 years of negative rates. But all the smarties were caught out last week when the BoJ lifted rates again to around 0.25% — even though everyone knew a further tightening was coming as the BoJ met for two days last week. Its decision to tighten rates and slowly reduce its bond buying seemed to take a day for markets to comprehend — Wall Street (and the ASX) hit all time highs or close to them on Thursday — before investors began selling to cover their now-more expensive Japanese loans.
Japan itself was hit worst: Tokyo’s 17% sharemarket slump on Monday was the biggest since the Black Monday sell off in October 1987. What does this tell us about the Japanese economy? Precisely nothing — in fact the Japanese services sector activity reading had a surprise rise in July, fueled by domestic demand, meaning that economy is chugging along nicely as well. All it told us was how overbought the Japanese sharemarket was. And Australia’s 3.7% plunge on Monday was nothing but a massive panic attack on top of the forced selling by investors unwinding their carry trade deals.
As a result, some screen jockeys are blaming the BoJ for the rout — as if a central bank should put the interests of traders and investors ahead of the real economy in setting policy. Maybe, instead of giving a platform like that to whingeing traders, Bloomberg should be asking its journalists why they didn’t spot the potential for a yen carry trade problem.
If anything, the BoJ move was unusually well-timed in knocking the froth off over-exuberant markets — a far cry from the Japan of “lost decades” fame, and from Australia, where we might be one ill-judged rate rise away from negative growth. Hopefully the RBA is explaining that to its board members today as well.
