In early August markets were volatile as almost simultaneously the Bank of Japan hiked interest rates at the same time as US employment data was released showing that payrolls softened. This led to the Japanese currency strengthening versus the US Dollar which in turn saw Japanese equity markets fall by over 20% in a day and US technology stocks sell off as the unwinding of the infamous “carry trade” occurred. However, by month end markets were little changed as fears of a massive unwinding of the carry trade dissipated.

What is the carry trade and why is it important? Effectively the carry trade is a decades long phenomenon whereby investors borrow in a low yielding currency (i.e. the Japanese Yen which has yielded almost 0% since 2000) and invest in higher yielding assets and/or equities. When the Yen strengthened as quickly as it did in early August some investors were forced to repay their borrowings in Yen by selling the assets that had been bought with the cheap currency.

Whilst the unwinding of the carry trade has the propensity to dislocate asset markets, the extent of how much needs to be unwound (if it at all needs to be unwound) is up for debate. What was witnessed within markets in August was that buyers were willing to step in and purchase assets that were sold off resulting in a rather benign month in terms of end returns.

US inflation data fell to an annulised rate at the end of July of 2.9% which led to the US Federal Reserve Chair claiming that the “time has come” to start cutting US interest rates, potentially by up to 0.5% when the FED meets on the 18-19th September.

In Australia the unemployment rate rose to 4.2% in July. Importantly, this increase in unemployment was due to a record high participation rate of 67.1% indicating that there is a high number of people in jobs and looking to find jobs. The RBA held interest rates at 4.35% in August.

Australian large cap equities rose by 0.7% with very few surprises in the August reporting season. Unhedged Global equities were negative in the month (-1.2%), mainly due to the weaker US Dollar as investors priced in an increased probability of a cut to the US Fed Funds rate next month. Currency hedged global equities rose by +1.8% as the Australian dollar strengthened versus the US Dollar by 2 cents to close the month buying US$0.6765

The Australian 10-year government bond yield fell by 15bps to 3.97% and the Australian 2-year government bond yield fell by 20bps to 3.67%. The US 10-year government bond yield fell by 13bps to close at 3.90% and the US 2-year government bond yield fell by 34bps to 3.92%.

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Article source: Personal Financial Services Ltd (PFS)

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