Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, was flat for the week.
  • Recent market volatility seems to be attributable to the unwinding of short-term trading strategies tied to low volatility and to the usual target for investor ire: the Federal Reserve.

Over the last two weeks, volatility returned to global stock markets. On Monday, the Japanese stock market plunged over 12%, its worst day since 1987. That day, the S&P 500 fell 3%. The VIX, a gauge of US stock market volatility, shot up to its highest levels since the first crazy pandemic days in March 2020.

It is worth noting that the S&P’s drawdown from its July peak as a result of the selloff earlier this week was 6%. Going back to 1980, the average calendar year peak-to-trough pullback for the S&P 500 is 14%. The intra-year decline in 2023 was 10% - and the market ended the year up 24%. So, while it has not been an enjoyable few weeks for the market, it hasn’t been terribly unusual or even historically bad.  

Still, investors love to seek out tidy narratives to explain the stock market’s daily or weekly gyrations. This time, there was an onslaught of explainers on the technicalities of the “yen carry trade” and why its unraveling was driving markets down. “Yen carry trade” sounds smart and jargony. What it boils down to is that there were a lot of leveraged bets that market volatility would stay low. Volatility did not stay low, and those bets needed to be unwound by selling stocks.

The spark that rekindled volatility was likely a combination of two events. On Thursday August 1, the Federal Reserve’s Open Market Committee met. Fed Chairman Jerome Powell declared that the Committee wanted to see more positive data on inflation before declaring “mission accomplished” and committing to lowering interest rates. Given the cooling of the labor market in recent months, Mr. Powell’s press conference performance came off as stubborn and a tad out of touch.

The next day, the BLS announced that the unemployment rate popped up from 4.1% to 4.3%. Suddenly, the Fed’s words on Thursday sounded more than a tad out of touch. Markets had to recalibrate the odds that the Fed was making an outright policy error – keeping interest rates too high and tipping the economy into recession.

For the better part of the last year, investors had grown quite confident that the Fed was engineering a “soft landing” for the economy – a reduction in inflation to 2% without mass layoffs and rising unemployment. After Friday, the odds of a “hard landing” for the economy were no longer zero. The market sent a message to the Fed: time to pay attention to building risks in employment.

More employment data came out later in the week that seemed to calm market fears, for now. The S&P 500 ended the week almost exactly flat.

The yen carry trade’s unwinding and the Fed’s apparent obstinance are logical explanations for why the stock market swooned over the last few weeks. It is not easy to quantify the impact of either of those stories, however. Another possible contributor to the massive selling and buying: human beings acting on emotion and trading for profit.

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