Wall Street suffered its sharpest decline in nearly two years on Aug. 5, joining a global stock rout driven by a confluence of factors, including growing fears that the U.S. economy may be spiraling into a recession.
Weak readings on the job market and manufacturing in the United States last week reinforced concerns that the Federal Reserve may have waited too long to cut interest rates, dimming hopes for a soft landing and causing investors to pivot away from risky assets such as stocks and seek refuge in the safety of bonds.
The selloff continued on Aug. 5, with the VIX market volatility measure, dubbed the Wall Street “fear gauge,” spiking intraday to its third-highest level in history, after the Lehman Brothers collapse in 2008 and the COVID-19 meltdown.
By closing bell on Wall Street, the benchmark S&P 500 Index had fallen by 3 percent, shedding 160.23 points, to close at 5,186.33. The Dow Jones Industrial Average plunged by 1,033.99 points, or 2.6 percent, ending the day at 38,703.27, while the tech-heavy Nasdaq composite dropped by 3.4 percent, closing at 16,200.08. The Russell 2000 index of smaller companies ended the day down by 70.15 points, or 3.3 percent, at 2,039.16.
“The sell-off started off with the jobs data last week, and it clearly led to the belief that the Fed needs to start being more proactive around where those unemployment numbers are going,“ said Neville Javeri, head of the Empiric LT Equity team at Allspring. ”It clearly continued over the weekend, the carry trade in Japan, and now today, we’re seeing a sell off as an extension of that anxiety that was felt last week.”
Jittery investors in Japan sent the Nikkei plunging by more than 12 percent on Aug. 5, its worst drop since 1987, after the Bank of Japan raised interest rates even as many of the world’s central banks were either holding steady or on a rate-cutting trajectory. Part of the dynamic roiling markets in Japan was a massive unwinding of a so-called carry trade, whereby investors borrowed in yen at very low interest rates and invested that money in high-growth, high-risk assets.
When the Bank of Japan raised rates on July 31, taking them from 0.1 percent to 0.25 percent and signaling that more hikes are possible, this created a big incentive for traders to unwind their carry trades to pay back yen-denominated loans as quickly as possible. Given the massive amount of money involved, the unwinding had big effects on markets.
“It’s really a confluence of things,“ said Eric Wallerstein, chief market strategist at Yardeni Research. ”You have the rapid unwind in yen-funded trades and geopolitical tensions in the Middle East. Both the shekel and the Israeli stock market are down, and you had a lot of crowded positioning in tech. And then we had kind of a weak employment report along with some weakish earnings. So it’s like five things hitting it once.”
Bonds were the beneficiaries as investors fled risky assets. U.S. Treasury yields tumbled to their lowest level in a year, and a closely watched gap between two- and 10-year Treasury notes turned positive for the first time since July 2022. Historically, this reversal has tended to indicate that the economy is heading into a recession.
Some analysts said that positioning was a factor in the big selloff of Aug. 5, as a number of stocks, in particular in the U.S. tech sector, were over-owned and “some froth needed to be cleared,” according to Mohit Kumar, chief economist for Europe at Jefferies in London.
