by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with an overview of the sharp declines in global financial markets today. Given the recent weak economic data out of the US and the surging value of the yen, the volatility could stay with us in the near term. We next review several other international and US developments with the potential to affect the financial markets today, including new signs that Iran is about to launch an attack on Israel and additional notes on Friday’s weak US labor market report.

Japan: Responding to Friday’s weak US labor market data, rising Japanese interest rates, and the surging yen (JPY), the country’s benchmark Nikkei stock market index plunged 12.4% today, for its worst decline since 1987. The plunging Japanese market pulled down stock values across the region, with the South Korean and Taiwanese markets both falling more than 8%. European equities are also weaker today, and as noted above, current futures trading suggests US stock prices will fall sharply at the open.

• The weak US employment data on Friday has rattled investors worldwide. To complement the quick first take that we provided in our Comment on Friday, we provide a bit more detail later in today’s publication. We also note that today’s upcoming business-sector data from S&P Global and ISM could help calm the markets if they are strong enough.
• The Bank of Japan’s shift toward higher interest rates has also upset the years-long habit among some investors to borrow at ultra-low Japanese rates to fund aggressive bets around the world. With Japanese rates now rising, investors have begun to unwind those trades, taking air out of many high-flying stocks and pushing the JPY higher as they bring their funds back home. The resulting upward pressure on the yen then prompts even more unwinding.
• After weakening some 12.2% against the dollar in the first half of 2024, the yen has reversed almost all of that change in just the last five weeks. As of this writing, the currency is trading at 142.68 per dollar ($0.00701), down just 1.3% from the exchange rate of 140.85 ($0.00710) at the end of 2023. If the JPY continues to strengthen, the global market volatility seen today could continue for a while yet.

Japan-Philippines: In another sign that key US allies in the Indo-Pacific region are increasingly cooperating to thwart Chinese geopolitical aggressiveness, Japan and the Philippines held their first-ever joint naval exercise in the South China Sea on Friday. The drill came just weeks after Tokyo and Manila signed a deal allowing them to deploy troops on each other’s territory in time of conflict. Separately, the German and Philippine defense ministers met yesterday to work on a new defense cooperation deal expected to be signed later this year.

China: The Wall Street Journal on Saturday carried an interesting article on the enormous scale of Beijing’s support for Chinese manufacturers. For example, the article says Beijing channels almost 5% of national income to support the factory sector, six times the share provided by the second-biggest spender, South Korea. Just as important, the article notes that 99% of China’s publicly listed companies report some kind of direct government subsidy. In 2023, the top recipient was battery maker CATL, which got about $790 million.

• The Chinese Communist Party has long maintained an investment-driven economic model marked by high spending on infrastructure, housing, and factories. Since the prior emphasis on housing left that sector with enormous excess capacity and debt, the party is now emphasizing factory investment and competitiveness.
• Along with the outright cash subsidies, Chinese manufacturers receive tax breaks, cheap loans from state-owned banks, low-priced land from provincial and local governments, preferential pricing for raw materials and energy from state-owned producers, and even inexpensive equity financing by government-run investment companies. Beijing also provides valuable non-monetary support, such as discriminatory rules against foreign firms operating in the country and low regulation on Chinese firms.
• Within China’s domestic economy, channeling so many resources to manufacturers leaves much less available for service firms and consumers. Even when Beijing vows to boost consumer spending, the strategy is often underwhelming. Over the weekend, for example, the State Council released a plan to boost consumer spending by increasing support for nursing care and “low altitude tourism,” i.e., hot air balloons.
• Internationally, the resulting excess capacity and low domestic prices have prompted Chinese manufacturers to dramatically ramp up their exports, which threatens to hurt manufacturers and manufacturing workers in the US, other developed countries, and even many emerging markets. As a result, we expect those countries to continue slapping Chinese firms with anti-dumping tariffs and other trade barriers, which will further worsen China-Western tensions.

Malaysia: Government officials, academics, and business managers say the number of Chinese citizens moving to Malaysia has surged in response to China’s slowing economic growth and oppressive Communist Party intrusions. According to the report, the surge is driven largely by students and investors. The number of Chinese citizens living in Malaysia may now be as high as 200,000, up from just 82,000 in 2022. The influx may help goose the Malaysian economy and stocks, although it could also spark social tensions.

European Union: Even though Ursula von der Leyen secured a second term as president of the European Commission earlier this summer, with support from both the EU member states and the European Parliament, she has faced an embarrassing threat to her authority as she works to fill the 27 commissioner posts in the EU’s executive body. For each country that is not just renominating its existing commissioner, von der Leyen has requested both a male and a female nominee. However, at least six countries have simply nominated a man.

• Under EU law, each member state has the right to nominate one commissioner. Then, von der Leyen gets to decide which portfolio each commissioner gets.
• Von der Leyen has promised to build a gender-balanced college of commissioners, but she has no authority to require both a male and a female nominee from each member state. Most returning commissioners are likely to be men, so without more female nominees, the new college of commissioners will likely be male dominated.

United Kingdom: Rioting by far-right activists spread to more cities over the weekend, as a follow-on to the anti-immigrant riots sparked last week by a stabbing attack that killed three children in the city of Southport. Prime Minister Starmer held an emergency meeting with his top ministers on Saturday and declared the government’s full support for police trying to control the violence. Nevertheless, the rioting threatens to disrupt economic activity and tarnish the UK’s reputation as a safe place for business and investment.

Iran-Israel: Tehran today issued a warning for pilots and aviation authorities to consider Iranian airspace off-limits, in what is likely an indication that it will soon launch its expected strike on Israel. Meanwhile, US Secretary of State Blinken yesterday told the Group of 7’s foreign ministers that he expects Iran to attack in the next 24 to 48 hours. Given that world financial markets are already facing economic jitters, an unexpectedly large, dangerous attack that threatens escalation could spark additional market volatility.

United States-Vietnam: In an annual review, the US Commerce Department on Friday unexpectedly maintained its designation of Vietnam as a “non-market economy,” keeping it in the same category as countries like China and Russia. The designation means Vietnamese imports into the US will continue to face special anti-dumping and anti-subsidy scrutiny and higher tariffs.

• The US decision comes despite Hanoi’s recent economic reforms and increased US investment in Vietnam. At first glance, it also seems inconsistent with the US’s recent pressure on Western firms to shift production from China to other countries in the region.
• On the other hand, it’s important to remember that Chinese companies have been looking to set up shop in Vietnam, Mexico, and other countries to get around US tariffs on Chinese products. Keeping Hanoi’s non-market designation may give the US more leeway to impede Chinese goods being routed through Vietnam.

US Defense Policy: Faced with growing threats from China, Russia, and North Korea, a senior Defense Department official said at a conference last week that the military’s current strategic review is exploring an increase in the US arsenal of nuclear weapons and launchers. The statement suggests the Biden administration may already be stepping back from its 2022 Nuclear Posture Review, which some defense analysts considered too dovish. If so, it could portend even more pressure to increase the US defense budget in the coming years.

US Labor Market: Finally, as a follow-up to our quick take on the weak July employment report in our Comment on Friday, we note that much of the issue was that new job creation finally fell sharply below the number of new entrants into the labor market. Our analysis shows most of the weakness came in the private sector, where the net employment gain in July was just 97,000, down 42.3% from the monthly average of 168,000 over the previous year. In the public sector, the jobs gain was 17,000, down 63.9% from 47,000 over the prior year.

• In the private goods-producing sector, net hiring in July was a bit stronger than in the prior year. The problem was in the private services sector, where net hiring weakened to 77,000, down 51.8% from the average of 149,000 in the previous year. In large part, that reflected weaker hiring in ambulatory healthcare offices and professional services, along with payroll declines in industries such as publishing and other information services.
• In the public sector, the weak hiring primarily reflected employment declines in state and local governments outside of education.
• While we’re still working to deeply understand what’s going on in the labor market, the weak labor demand in professional and information services may mean firms over-hired in those areas in the post-pandemic boom. Potentially, it could also point to some shifts related to artificial intelligence. Finally, the weakness in governments’ non-education hiring could reflect continued strong retirements in that relatively older sector.
• In any case, if the weak July figures aren’t reversed in the August report, the Fed policymakers certainly could become more amenable to a 50-basis point cut in the benchmark fed funds rate in September, as many investors now expect.

View PDF