Investors should blame the Bank of Japan, not the Federal Reserve, for Monday’s sharp decline in global markets, an economist says.
The plummet, which led to the greatest losses in the Dow Jones Industrial Average and the S&P 500 in almost two years, was caused by the unwinding of the Japanese yen “carry trade,” which began when Japan’s central bank raised interest rates, said Jim Bianco, founder of Bianco Research.
It also led to Japan’s Nikkei 225 index dropping 12.4% on Monday to mark its largest drop in decades.
Sometimes, unexpected changes in the markets’ financial structure — instead of quick changes in economic forecasts — can jostle markets, but not this time, he said.
“The most recent move in the markets has been driven by the Bank of Japan's larger-than-expected hike last week, which led to a subsequent unwinding of the yen carry trade,” he wrote on X on Tuesday.
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“In other words, everyone is right to be mad at the central bank. The problem is that most blame the wrong central bank; they should focus on the Bank of Japan.“
The Bank of Japan raised its benchmark interest rate from 1% to 2.5% on Wednesday (July 31), prompting investors to exit the strategy, which involves borrowing cheaply against the Japanese yen to buy high-growth stocks.
This creates a dilemma for the Fed, which is expected to cut rates at its next meeting in September, Bianco said.
“The catalyst for the yen carry trade unwind is the narrowing of the interest rate spread between Japan and the U.S., which has been caused by the Bank of Japan’s hike,” he said.
“But if the Fed succumbs to market demands and cuts rates, it will narrow this spread further and worsen it.”
Economists have pointed to the Fed keeping rates unchanged and a disappointing jobs report last week as catalysts for Monday’s market selloff, which saw the Dow Jones Industrial Average lose almost 1,400 points.
The Dow, which is tracked by the SPDR Dow Jones Industrial Average ETF Trust (NYSE:DIA) gained 1.53%, or 591 points by Tuesday’s mid-afternoon trading.
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