By Vishwanath Tirupattur, global head of Quantitative Research at Morgan Stanley
It has been a wild August thus far in global equity and fixed income markets. In the first few days of month, the S&P 500 index fell over 6% and Japan’s Nikkei 225 index recorded a more dramatic 20% decline. Both indices have since recovered about half of these losses. Ten-year US Treasury yields dropped more than 20bp but are now back to the levels prevailing at the beginning of the month. Measures of market volatility in equity and interest rate markets – the VIX and MOVE indices – also spiked sharply. While they have declined from recent peaks, they remain elevated. In this week’s Start, we focus on the debates that led to the severe gyrations across the markets and how we expect them to unfold over the near term.
In our view, at the core of the market volatility is the changing market narrative about US economic growth – though it bears noting that our economists’ view of the outlook is unchanged, as we discuss below. While there have been downside surprises in the data over the last few weeks, such as the latest ISM Manufacturing PMI, the across-the-board softness in last Friday’s US employment report was the catalyst for the latest gyrations, bringing the risks of a hard landing into focus and, by extension, the Fed’s path for monetary policy. This contrasts with the particularly rosy thesis that had been baked into market prices, where valuations were already stretched. Market pricing of the Fed's rate cuts this year has changed dramatically yet again, from under two 25bp cuts about a month ago to now over five, with an over two-thirds probability of a 50bp cut at the September meeting.
