Recent stock market volatility has created questions regarding the sustainability of the current bull market for stocks. Typically, market volatility is inversely related to stock market performance (spikes in volatility are associated with stock market corrections). While most Canadians were enjoying the August long-weekend, global stock markets experienced a sharp correction due to concerns surrounding a U.S. recession and the unwinding of the ‘Yen carry trade’.

U.S. recession concerns have grown due to a recent increase in the U.S. unemployment rate in combination with the view that the consumer is showing signs of fatigue after years of higher interest rates and inflation eroding their purchasing power. This view has been reinforced by recent quarterly results from companies like McDonalds who are stating that customers are pushing back on price increases for their products. After years of being able to pass higher input costs onto consumers, further price increases are beginning to impact sales.

The Yen carry trade is used by institutional investors to borrow Japanese Yen at a very low interest rate and invest borrowed funds in a currency or asset with a higher yield than their cost to borrow. This trade requires borrowing funds in Japanese Yen; therefore, it is susceptible to changes in interest rates, foreign currency levels and relative economic growth prospects. The recent market sell-off was caused by the Bank of Japan increasing its overnight interest rate by 0.25% while the U.S. Federal Reserve guided the market towards interest rate cuts. This relative change in interest rate policy between Japan and the U.S. caused an increase in the value of the Yen relative to the U.S. dollar which, in turn, caused investors to sell stocks to repay their Yen borrowings.