Is the Pessimism Over?

The big question circulating in investors’ minds must probably be whether the recent market moves are just a foretaste of a larger downturn or simply a temporary correction.

The answer delves into the reasons for the sudden change in market sentiment. Once the latter is understood, it may become clear whether the same scenario will repeat itself.

Let’s start by saying that a prevailing theory is that investors suddenly fear that the US is headed for a recession, given the continued weakening of the labor market.

Similar news in the past would have sparked optimism by suggesting that the Federal Reserve might tighten monetary policy. But now, fears of a hard landing have surfaced.

However, Monday’s ISM services PMI data, which showed an increase of 2.6 points to 51.4 in July, cast doubt on the worst-case scenario (a deep recession).

Another factor cited by the media was the pullback in technology companies due to downbeat earnings reports and a generally uncertain outlook.

But there could be another element at play: a global margin call.

The trigger was the sudden strengthening of the Japanese yen, driven by the Bank of Japan’s more hawkish stance, which recently raised its interest rate to 0.25%.

In addition, the BOJ pledged to halve its bond purchases, reducing them to about 3 trillion yen ($19.9 billion) by the first quarter of 2026. In other words, goodbye Abenomics…

As a result, USD/JPY fell sharply to 150. It seemed that this was precisely the Bank of Japan’s target. So, how could this move have impacted international markets?

The problem is that investors have long been borrowing in the Japanese yen because of its lower rates, investing in assets in countries with higher rates, and engaging in carry trades.

With the Bank of Japan’s policy change, those borrowed in yen suffered losses, leading global investors to liquidate their positions in foreign assets and buy yen instead.

This led, on the one hand, to a massive sell-off of risky assets and, on the other, to a further strengthening of the yen. In other words, we witnessed a global margin squeeze.

Interestingly, the strengthening of the yen has had very adverse effects on other major markets worldwide in the past. So, such a phenomenon has occurred before.

What is the verdict?

Beyond macroeconomic indicators and geopolitics, investors will now closely monitor the yen. Thus, we can see a more emotional move in the coming days or even weeks.

The big question now is whether the Fed could call an emergency meeting or whether the recent improvement in market confidence will make them hesitate to take urgent action.

This article was written by FL Contributors at www.forexlive.com.