While services data offers relief, concerns about the U.S. economy persist

08/06/2024

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Ruy Alves — Foto: Leo Pinheiro/Valor

Global markets plunged into panic amid mounting fears of a U.S. recession in Monday’s trading session. Risk aversion gripped investors from the early hours, starting with Japan’s stock market experiencing its second-worst day ever and continuing across global stock markets throughout the day. In Brazil, concerns pushed the exchange rate to its highest close since March 2021, while Brazil’s benchmark stock index (Ibovespa) also fell, though local asset losses were less severe compared to their international counterparts.

The day’s trading commenced with high tension as Asian stock markets recorded substantial losses driven by fears of a U.S. economic slowdown and concerns over a tech stock bubble. Japan’s primary market index, the Nikkei, plummeted 12.4%, marking its steepest decline since 1987, and South Korea’s Kospi index closed down 8.7%.

U.S. markets mirrored this downward trend, with significant indices suffering heavy losses. The Dow Jones Industrial Average dropped 2.60%, the S&P 500 declined by 3.00%, and the Nasdaq Composite fell 3.43%, dipping over 6% at one point during the session. The S&P 500 experienced its worst day since September 2022. Furthermore, the VIX index, often referred to as Wall Street’s “fear gauge,” surged by 65%, ending the day at 38.57 points.

In a communication to clients, strategists at Citi noted that the investment strategies widely adopted by the market are now showing their limitations. “Positioning metrics shed light on some of the recent movements in asset classes, providing insights into vulnerabilities during periods of high volatility. Japanese stocks were widely favored […], and equities in Europe, the U.S., and emerging markets (excluding China) remain overweight,” they commented.

Citi highlighted that “carry trade” positions—where investors borrow at low interest rates in one country to invest in higher interest options elsewhere—are particularly vulnerable, impacting currencies such as the Brazilian real, the Turkish lira, and the British pound.

Amid these global tensions, local markets displayed a stark aversion to risk. At one point during the day, the exchange rate surged by 2.71% in Brazil, reaching R$5.8641 per dollar. Simultaneously, the Ibovespa plummeted to a low of 123,073 points, a drop of 2.20%.

Nevertheless, unexpectedly positive data from the U.S. services sector tempered fears of an imminent recession in the world’s largest economy, leading to a partial recovery in market sentiment. Consequently, local assets rebounded from their lowest points of the day. By the close of trading, the exchange rate had risen by 0.56%, settling at R$5.7412 per dollar, marking a year-to-date gain of 18.31%. Meanwhile, the Ibovespa closed down slightly by 0.46%, at 125,270 points.

Ruy Alves, global macro manager at Kinea, expressed confidence that there is no imminent recession on the horizon for the U.S., nor is there a likelihood of a sharp economic downturn. According to him, the recent monetary policy meetings of the U.S. Federal Reserve and the Bank of Japan have led to a recalibration in risk perception among highly leveraged trades, contributing to the recent market corrections. “It’s a misconception to think that the market consistently aligns with economic fundamentals. In reality, the market is shaped by supply and demand dynamics, which only sometimes coincide with the fundamentals,” he explained.”

The executive is optimistic about the potential for the Brazilian real to recover from its recent excessive fluctuations compared to its counterparts. “The real has room to correct some of the unusual movements it has experienced in recent months,” observes Mr. Alves. He notes that despite the market turbulence, the currency has shown considerable resilience relative to its peers.

Echoing this sentiment is Sérgio Goldenstein, chief strategist at Warren Investimentos. He suggests that the anticipated Federal Reserve rate cut of 0.5 percentage points should, in theory, benefit emerging market assets, particularly currencies. However, he points out that there is volatility stemming from the unwinding of carry trade operations.

“The yen has risen about 10% in a month. Fortunately, this appears to be a cyclical trend. Notably, on Monday (5), the real managed to outperform other emerging market currencies. If this unwinding of positions has concluded, it suggests that the real is poised to adjust to a more favorable rate. Currently, the currency stands well above its equilibrium rate,” Mr. Goldenstein explains.

He believes that an improvement in the exchange rate could significantly alleviate the Central Bank’s inflation concerns. “Should the Fed initiate rate cuts in September, combined with the cessation of ‘carry trade’ unwinding, there could be an opportunity for the real to appreciate, potentially reducing inflation projections. This scenario would enable the Central Bank to maintain the Selic [Brazil’s benchmark interest rate] at a stable level over an extended period,” he adds.

*Por Gabriel Roca, Gabriel Caldeira, Maria Fernanda Salinet — São Paulo

Source: Valor International

https://valorinternational.globo.com/