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PICKING UP THE PIECES

The S&P 500 clawed its way upward on Friday, riding the wave of an incredible comeback after Monday’s wild VaR shock. Japan found itself smack in the middle of the chaos as a surging yen sent local markets reeling and unleashed a tidal wave of carry trade unwinding. The Bank of Japan didn’t just catch the market off guard—they practically yanked the rug out from under it with an unexpected rate hike that left traders scrambling. The result? A global market carnage of epic proportions. Honestly, it was one of the most jaw-dropping currency-wrecking ball moves I’ve seen in ages—maybe ever. Talk about a plot twist no one saw coming!

It was a classic case of Murphy’s Law in action—everything that could go wrong did go wrong for investors. The U.S. markets were already staggering from the dismally poor Non-Farm Payrolls report the previous Friday, and then, bam! We hit an intersection of not one but several flashpoints. It was like watching a slow-motion car crash where every new impact made things worse. The markets were caught in a perfect storm, with no safe harbour in sight.

Once the bulk of "at risk" carry trades had been unwound( JPM thinks 75% as of Thursday close)  —thanks to a generous sprinkle of dove dust from the Bank of Japan ( jawboned  USDJPY higher for local to sell at a small loss) and what I still see as an overreaction to better-than-expected U.S. tier two data( Jobless Claims)—the Vol control and systematically forced sellers, who had driven the market lower, were suddenly forced to step back in. The VIX, which had spiked like a firecracker, fizzled out just as quickly when it became clear that neither a systematic crisis nor an impending recession was lurking on the horizon. It was a classic case of the market getting ahead of itself, only to slam on the brakes when cooler heads prevailed.

While it was a bit more than your typical August thin-market volatility, last week’s sell-off and subsequent bounce-back had all the hallmarks of algos running wild—where irrationality often reigns supreme. But rest assured, last week’s market frenzy will unlikely dictate what we’ll face next month. Instead, the real fireworks could come from a combination of a slowing global economy, political uncertainty in the U.S., tensions in the Middle East, and growing doubts over the A.I. hype. Any one of these factors could inject a fresh dose of volatility into the markets at any moment.

And while we are coming off a week where the labour market hogged the spotlight, next week, the Fed’s other love—inflation—takes center stage. We’re about to get a fresh serving of July’s CPI and PPI reports as well as a side of hard data on July retail sales. These could throw a wrench into the growing chorus calling for a 50-basis point cut at the September meeting.

Here’s the scoop: I’m anticipating a small bump in CPI inflation (both headline and core), which will likely remind everyone that inflation isn’t going down without a fight. Thanks to some pesky base effects, annual growth could stick around longer than we’d like, kind of like that one guest who won’t leave the party.

Retail sales are expected to keep inching up just above the pace of inflation, signalling that not all consumers are tightening their belts just yet. It’s a sign that modest-to-moderate retail consumer spending is still alive and kicking. So, while some may be bracing for a big Fed cut, next week’s data could very well stir the pot and keep everyone guessing.

NUTS & BOLTS

Equity markets might have ended the week with barely a scratch, but don’t let that fool you—it was a white-knuckle ride from start to finish. The S&P 500 closed flat only after taking a 4% nosedive earlier in the week, fueled by a perfect cocktail of chaos: unwinding yen carry trades, U.S. election drama, and a much-needed reality check for tech valuations.

Banks and energy stocks strutted their stuff, posting solid gains, while materials, utilities, and consumer discretionary stocks were left eating dust. Meanwhile, the VIX—our market’s trusty fear-o-meter—spiked above 38, not quite hitting panic-button levels, but definitely high enough to make traders sweat a little. It wasn’t the apocalypse, but compared to some of history’s biggest market blowouts, it was enough to keep things spicy. So, while the week may have wrapped up on a calm note, it was a rollercoaster ride that traders won’t soon forget.

The market’s latest obsession? The economic outlook, where the fear of slowing growth has muscled its way past the lingering threat of inflation. Suddenly, everyone’s looking at the Fed like it’s the tortoise in a race with the economy, and investors have become hypersensitive to any whiff of weakening activity.

Let’s take a dramatic trip down memory lane to that infamous 1987 crash. Sifting through 10 epic market meltdowns where the VIX shot up to 35 or higher, and here’s the kicker: the triggers for these freakouts were all over the map. We’re talking everything from technical meltdowns (1987, 2010) and global economic shocks (1998, 2015) to pandemics (2020) and classic recessions (1990, 2008). Every time, equities didn’t just dip—they dove headfirst into a 10% or more correction and, in some cases, spiralled into deep bear markets, like during the Global Financial Crisis. Treasury yields usually nosedived, and more often than not, the Fed had to jump into action. And here’s the clincher: a U.S. recession followed 4 out of these 10 market dislocations.

So, what’s the big takeaway? While a recession often follows a major market meltdown, it’s not a given. Not every market freakout means we’re on the brink of a recession—it all depends on where we are in the economic cycle. But let’s not kid ourselves; this time around, we’re dealing with a cocktail of aggressive tightening and an inverted yield curve, so it’s definitely not something to brush off. In other words, this isn’t just another market tantrum—it’s a wake-up call that deserves some serious attention.

OIL MARKET

U.S. crude oil skyrocketed over 4% this week as recession fears took a backseat and the threat of a broader Middle East conflict loomed large, casting a shadow over production and transportation. This market was all about hedging against a potential powder keg, keeping the New York session sizzling with a strong "tinderbox hedge" bid.

The Middle East is on a knife’s edge after the assassination of Hamas leader Ismail Haniyeh in Tehran last week. Israel, anticipating potential retaliatory strikes from Iran and Hezbollah in Lebanon, is on high alert. Meanwhile, the U.S. is frantically working the diplomatic circuits to keep things from boiling over. But with high tensions, the oil market is on red alert—any spark could send prices soaring, making it a wild ride for traders. So, buckle up—it’s going to be a spicy one!

THE 12 WISE MONKEYS

As we put the recent market mess in the rearview mirror, it's time to turn our attention back to the FOMC, who seem to be navigating the financial landscape like they’re playing a game of "Eyes Wide Shut." The equity market has finally snapped to attention, realizing the risks on the employment side of the Fed’s dual mandate—something they haven't done since those recession rumblings back in 2022. Not wanting to be left out of the drama, the Fed subtly shifted gears in the July FOMC statement, now saying, “The committee is attentive to both sides of its dual mandate.” Gone is the hyper-focus on inflation; instead, they give equal weight to both sides of the scale. And to keep us all on our toes, Jerome Powell chimed in during the press conference, saying, “If we see something that looks like a significant downturn in the labor market, we would respond.” Translation: we're watching everything but reacting to nothing—until we absolutely have to.

Despite this cautious tone, the underwhelming July jobs report gave investors the perfect excuse to play armchair quarterback, accusing the Fed of being late to the game. The result? It's a mad dash to cash in their high-flying winners and trim some risk off the table.

At its lowest point this week, the S&P 500 took a 9% nosedive from its July 16 peak, while the Nasdaq plunged into correction territory, dropping over 10%. Sure, stocks managed to claw back a little ground over the past few days, but make no mistake—the markets are still walking on eggshells. The recent rollercoaster has been a wild ride, and now might be the perfect moment to take a step back, catch your breath, and reassess. Because after all that market drama, we’ve got to ask—what, if anything, has really changed?

Fortunately, the economic horizon isn't littered with glaring recession red flags in the U.S. right now. Nonfarm payrolls are still on the up and up, layoffs and initial jobless claims are keeping a low profile, retail sales are likely still climbing, and second-quarter earnings reports have not been too bad. The ISM Services Index didn't just hold its ground in July—it strutted its stuff and came in stronger than expected. Meanwhile, initial jobless claims took a 17K tumble to 233K, marking their lowest point in a month.

Over at the Atlanta Fed, the GDPNow estimate for Q3 held steady at a robust 2.91% as of August 8, barely budging from its recent readings. Not to be outdone, the N.Y. Fed's Nowcast clocked in at a healthy 2.24% on Friday. Both estimates flex well above the Bloomberg straw poll consensus of 1.5%. It's like the economy is saying, "Recession? Never heard of her."

It’s the sharp uptick in the jobless rate that has everyone jittery. At 4.3% in July, it’s already nudging past the FOMC’s median long-run rate of 4.2% and is noticeably above the 4.0% Q4 projection made back in June. The 0.6 percentage point rise in unemployment since January—and a 0.9 percentage point jump since its January 2023 low—has quickly become the focal point of economic discussions. Adding fuel to the fire, the Sahm Rule recession indicator was triggered in July, setting off alarms.

But hold on—Dr. Sahm herself has suggested that her recession indicator might be flashing a false alarm this time around. She points to the surge in immigration, which could be temporarily boosting the labour force and, in turn, pushing up the unemployment rate. In other words, we might see an increase in labour supply rather than a worrisome drop in labour demand, which would be a more traditional warning sign of an impending recession. So, while the headlines are screaming recession, the reality might be a bit more nuanced.

Trying to decipher what the Fed thinks is like reading tea leaves in a hurricane—it's the ultimate enigma in this economic puzzle. They strap on the blinkers when you think you’ve cracked the code.

If you are interested in reading a bit more on the “ Sahm “ rule, JP Morgan private banking just put out a nice readthrough: “What is up with the Sahm Rule, and what does it mean for the Fed? “

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