Summary
[Japan’s yen falls to a level not seen in 24 years versus the US dollar. World stock markets and oil prices fall on fears of rising interest rates and recessions. A recession can have the opposite effect on stock prices by lowering commodity prices. Inflation in Japan drove down the yen and pulled back the euro and sterling. Fears of a U.S. interest rate rise pushed the dollar higher.]
World stock markets and oil prices fell on Wednesday as the recurring fears of rising interest rates and recessions resumed. The Japanese yen, however, fell to a level not seen in 24 years versus the seemingly unstoppable US dollar.
As Europe experienced a morning decline of 1.5 percent and Brent crude prices fell by 4 percent following what had also been a dismal Asian session, the enthusiasm that had given Wall Street its greatest day in a month on Tuesday was abruptly gone.
Stocks, Oil, and Potential Recession (A flashback of the 2008/009 recession)
When fears of recession climb, investors often run to the “safe haven” of stocks. The reason isn’t especially complex: In bad economies, companies tend to do well and investors tend to hold their stock longer after a 10 percent drop. By contrast, fear drives investors into safer physical assets including commodity prices.
Oil prices fell from a high of $133.88 in June 2008 to a low of $39.09 in February 2009. Over the same time period, natural gas prices fell from $12.69 to $4.52.The lower price for oil and gas due to the financial crisis was the major impact on the sector.
As the recession comes with rising inflation and the Fed lowering rates, commodities prices may drop lower. As a result, a recession can have the opposite effect on stock prices. In fact, the beginning of a recession is normally characterized by a weak market and declining corporate profits.
Oil was only part of the equation that broke down as an overheated economy brought about a collapse in demand for everything from homes to financial products. Oil and stocks moved in tandem in the first half of 2008 as investors fled to financial assets at what became a record low level.
Stocks were down more than 50 percent and oil prices lost two-thirds of their value when stocks hit a bottom in March 2009. As fear eased, bulls took charge, pushing prices higher through a combination of market manipulation and strong global demand for energy.
Market Overview on the Verge of Recession
In the FX markets, fervent dollar bulls were also not holding back on their wagers that Federal Reserve Chairman Jay Powell will later emphasize to Washington the necessity of sharply raising U.S. interest rates.
Inflation in Japan is currently running at a 40-year high of 9.1 percent, according to data, which also drove down the yen once more and pulled back the euro, Norway’s oil-sensitive crown, and the British pound.
Quoting Saxo Bank FX strategist John Hardy as saying, Reuters writes, “It is remarkable how quickly the market has turned again after that little squeeze up in sentiment yesterday”.
Hardy also adds that the commodity market seems to be calling a (global) recession, and the dollar is pivoting to strength as a safe haven.
Those recession worries were also showing in the bond markets where U.S. and German government bonds rallied as traders sought out traditional safe harbors.
The yield on benchmark U.S. 10-year Treasuries decreased to 3.21 percent, and Germany’s 10-year yield decreased by 10 basis points (bps) to 1.65 percent after reaching its highest level since January 2014 last week at 1.928 percent.
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Although Jim Reid of Deutsche Bank was attempting to see the silver lining, Wall Street futures were down significantly more than 1%, suggesting that the S&P 500 was likely to consolidate what may have been its worst start to a year since 1932.
Pointing out that on four of those five occasions, the U.S. index went on to gain at least 17%., Reid said, “The 5 worst H1 performances for the S&P 500 before this year, all saw very good H2 performances”.
As reported by Reuters, Reid showed, “In order of H1 declines, we saw 1) 1932: H1 -45%, H2 +56%, 2) 1962: H1 -22%, H2 +17%, 3) 1970: H1 -19%, H2 +29%, 4) 1940: H1 -17%, H2 +10%, 5) 1939: H1 -15%, H2 +18%”.
Overnight, the largest MSCI index of Asia-Pacific shares outside of Japan fell 2.3 percent, nearly hitting a five-week low. Although Tokyo’s Nikkei (.N225) managed to limit its losses to only 0.4 percent, heavyweight Hong Kong-listed IT firms dropped almost 4 percent (.HITECH).
What could be the Risks of a Recession?
Investors are still determining how concerned they should be about central banks’ potential to cause the global economy to enter a recession while attempting to combat hyperinflation by raising interest rates.
The major U.S. market benchmarks increased by 2% overnight on the potential that the economic picture may not be as bad as initially believed during trading last week, when MSCI’s main global stocks index (.MIWD00000PUS) registered its largest weekly percentage fall since March 2020.
Invesco global market strategist for Asia Pacific David Chao said, “I think that this recent post-holiday bear market rally is a reflection of the uncertainty that investors have regarding whether we have seen the peak of inflation and Fed hawkishness or not – I think we’re close”.
Investors are waiting for more hints about whether another 75-basis-point rate hike is likely in July as U.S. Federal Reserve chief Jerome Powell is scheduled to begin his hearing before Congress on Wednesday.
According to economists surveyed by Reuters, the Fed will raise interest rates by 75 basis points next month, then by a half-percentage point in September. At the earliest, the Fed will reduce its rate hikes to quarter-percentage-point increases.
With the exception of the Bank of Japan, which promised last week to continue its policy of ultra-low interest rates, the majority of other global central banks are in a comparable position. In contrast, the Czech central bank was expected to hike its rates by as much as 125 bps later with inflation there well into double figures.
The difference between Japan’s low-interest rates and the United States’ rising rates has put pressure on the yen, which in Asian trading touched a record 24-year low of 136.71 per dollar before sliding up to 136.20.
The Bank of Japan’s central bank expressed concern about the potential effects of the country’s depreciating currency on the business environment in the minutes from its April policy meeting, which were published on Wednesday.
Commodity markets saw another significant movement. The 18.4-cent-per-gallon federal fuel tax was likely to be temporarily suspended later by US President Joe Biden, according to a person familiar with the proposal, which coincided with the 4% decline in oil prices.
Brent dropped $5 to $109.79 a barrel, while U.S. crude fell 5.9% or $5.37 to $104.15. Metals buckled too with copper, nickel, aluminum, and tin all down between 2.9% and 5.2%
Talking about oil and pointing to an expected summer demand surge, PVM’s Stephen Brennock said, “The latest in a long line of attempts to temper surging prices at the pumps is having the desired effect”.
“Yet whether this knee-jerk reaction will stand the test of time is by no means guaranteed”, added Brennock.
Precautions, Preventive Measures for Investors in this Situation
In this situation, investors could take the following precautions to deal with this situation:
1) Reduce risk exposure within the portfolio: A diversified portfolio across different asset classes helps to balance risk, but during a recessionary period, investors might want to move more money into cash and low-risk instruments such as government bonds.
2) Use stop losses/stop limits: Investors might want to consider the use of stop losses or stop limits on long positions in stocks. Stop Losses or Stops will prevent market orders from being triggered unless the stock trades at or above a certain price. This helps to protect against steep declines.
3) Reduce the amount of risk taken on by the portfolio: Investors may want to reduce their exposure by using stop-loss orders, thus reducing their risk in the event of a sharp decline in the market.
4) If a portfolio is to be bought back during a bull market: Investors should take care not to purchase any longer-dated call options or put options after currency or commodity markets have turned bearish. Investors could get hit with substantial losses if they decide to sell out at too low a price as many international currencies have fallen significantly against both the dollar and commodities.
5) Remember you can hedge your portfolio: Hedge your portfolio adequately to protect yourself against negative moves. A good example is an investor who wanted to buy a currency pair might choose to purchase a Put Option to protect himself in the event that the currency pair went against him.
Having said that, investors should not avoid risk completely and try to limit their exposure as much as possible. Also, they should keep a close eye on their portfolio and manage it accordingly.
