Just a couple months ago, we were talking about the U.S. economy being too strong and they probably won’t start cutting interest rates until the end of this year.
Canada took the initiative and started our first rate cut in June, then again in July, but the rate cuts were too little too slow for us to see any immediate effect on the economy.
Well, this world is changing fast.
When we were enjoying our long weekend a few days ago, something drastic happened and now everyone is talking about the possibility of an emergency rate cut in the U.S.
Of course, what’s going to happen in the U.S. is going to have a significant impact on Canada.
Let me summarize all the movements over this past week for you.
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On August 5, the stock market worldwide experienced a significant crash.
In the U.S., the Dow Jones, S&P 500 and Nasdaq all recorded their biggest one-day losses in nearly two years.
Japan’s Nikkei 225 plunged 12%, its worst day since the Black Monday crash of 1987.
Other markets in Asia and Europe also suffered significant losses.
What happened?
There were 2 major events that triggered the widespread sell-offs.
#1 The Weaker-Than-Expected Job Report
The U.S. job report released on August 2 showed that only 114,000 jobs were added in July, way below the expectations of economists.
The unemployment rate also rose from 4.1% to 4.3%.
While it is not too unusual to see a weaker than expected job report, this particular one has unusual significance.
Because it triggered the Sahm Rule.
What the heck is that?
The Sahm Rule is a formula used to predict recessions and the most scary part is that it has successfully identified every U.S. recession since 1970.
Here’s what the rule says.
We take the 3-month moving average of the unemployment rate.
If the average rises by 0.5% or more relative to the previous 12-month low, then we are likely going to see a recession.
The current 3-month moving average of the unemployment rate in the U.S. is 4.2%.
The lowest unemployment rate in the past 12 months was 3.5%, recorded in July 2023.
This means the 3-month average is 0.7% above the 12-month low.
This increase exceeds the 0.5% threshold specified by the Sahm Rule.
With the scary accuracy of the rule, a potential recession is in sight.
This is one of the two big reasons that triggered the sell-offs in the stock market.
#2 Rate Hike in Japan
For an extended period of time, the Bank of Japan maintained a policy of ultra-low interest rates, in the range of 0 to 0.1%, to combat deflation and stimulate economic growth.
So for years, investors around the world had borrowed Japanese yen at ultra low rates and invested it in higher-yielding assets elsewhere. This is called carry trade.
On August 5, the Bank of Japan announced a rate hike of 15 basis points.
It came as a surprise to many investors and market analysts, they didn’t expect Japan to make any changes to its long-standing low interest rate policy.
This unexpected rate hike led to a strengthening of the Japanese yen against other currencies.
Now it is more expensive for investors to pay back the yen they borrowed.
It triggered margin calls and forced investors to unwind their carry trades.
The result was massive sell-offs in stock markets and assets that were previously financed by cheap yen loans.
So the job report and the rate hike in Japan were the major events that crashed the stock markets on August 5.
Although the stock market has recovered somewhat since then, the damage has been done, there is a lot of fear in the market.
The discussion is not about the rate cut in September anymore, that’s already too far away.
There is considerable market pressure for the Fed to take immediate action.
The speculation is now on the possibility of an emergency rate cut before September.
The swap market has priced in a 60% chance of a 25 basis point rate cut within the next week.
It is that serious.
Of course, the markets are changing too fast these days and no one can really predict what is going to happen next.
I do think the general trends are becoming clear though.
My personal prediction is that we are going to see big rate cuts, fast, in both the United States and Canada.
Before I close off, let me also give you a brief update on the Toronto real estate market because the July market watch report just came out a few days ago.
In June, when we compared the sales activities with a year ago, we were 16.4% down.
At the same time, we also had 67.4% more active listings.
Now let’s take a look at the July data.
Sales activities were actually up 3.3% compared to last year.
And the number of active listings were 55% more.
So the market has become slightly more active, helping to digest some of the listings on the market.
Prices are still more or less flat, I don’t expect to see much movement on pricing until a good chunk of available listings are consumed.
Historically, housing prices come down at a relatively slow rate, even on a crash.
When prices go up, they typically go up at a much faster rate.
Did you notice that as well?
There are many interesting reasons to support that observation and we are going to talk about them in another video.
If we were to see big rate cuts fast, what kind of effect would that have on the housing market?
Comment below and let me know.
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