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Cailianshe News, August 5 (Editor: Xiaoxiang)So far this week, most global market participants have been asking a simple question, “Why are people selling so hard?”

The Japanese stock market collapsed, the US stock market collapsed, and even the European and emerging market stock markets also suffered a significant blow.Lindsay Matcham, a trader at Goldman Sachs, listed a series of reasons that traders now believe have driven the sudden "freezing" of global risk appetite from the perspective of a market participant last weekend:

Japan's yield curve flattens

The Bank of Japan raised rates last week while emphasizing that real interest rates are negative and leaving the door open for future rate hikes. Japanese stocks initially cheered the news, with large bank stocks rising 4.50%. However, local interest rate markets are beginning to paint a more bearish picture; the Japanese 2-year to 10-year bond yield (2s10s) curve has begun to flatten sharply, indicating thatThe rate hikes and potential future rate hikes were priced in as a constraint on Japan's economic growth and inflation, ultimately hitting Japanese stocks.

(Japanese bond 2s10s curve)

Yen strengthens/profit closing

The yen has strengthened significantly against the dollar recently, which has triggered the unwinding of carry trades in a self-reinforcing/negative feedback loop process - as stops are triggered, previously overextended carry positions are increasingly unwound. When last week's US data disappointed, the yen was sought after as a safe haven in the foreign exchange market, whichThis further exacerbated the trend and disrupted market positioning and pricing, resulting in a series of chain reactions on global risk assets.

Related report from Cailianshe: "The yen surges & tech stocks plummet: Are all these somehow connected?"

Powell keeps close eye on labor market

Powell's speech at last week's interest rate meeting did not bring any real surprises. As expected, Powell hinted at a rate cut in September and left open the possibility of more rate cuts in the future, while also talking about the fragility of the labor market. The market has shifted from extreme concerns about inflation to extreme concerns about slowing economic growth - all eyes are on the labor market. Powell said,He is watching carefully to see if the labor market sees a bigger downturn, which is keeping markets on alert.

Soft landing expectations hit

The 2008 recession was caused by a large accumulation of private and household debt, but in this cycle, all the debt was previously driven by fiscal stimulus, with central banks printing a lot of money to fill the hole caused by the epidemic and try to boost economic growth (these debts can be easily managed by central banks), and the debt situation on household and corporate balance sheets is relatively good.

This has allowed interest rates to remain high and goes some way to explaining why the economy has not had any problems despite such tight financial conditions, and why markets have been pricing in a soft landing for some time.

However,With economic growth now slowing and inflation being left behind, markets are becoming extremely sensitive to negative data, coupled with the potential lagged effects of a high interest rate environment on employment, growth and the economy becoming increasingly apparent, which is why we are beginning to enter an environment where bad news for the economy is bad news for the market.

Bad news is bad news

The market believes that the manufacturing purchasing managers' index is extremely important for the direction of economic trends. Last Thursday, the US ISM manufacturing index fell further to 46.8, far below the industry's consensus expectation of 48.8, which caused panic in the market.

This can be deduced as: ISM manufacturing index is in recession range + US federal funds rate is at a high level above 5.25% = soft landing atmosphere evolves into recession concerns = typical global macro risk aversion (Risk Off) sentiment breeds.

The U.S. unemployment rate for July, released last Friday, also rose further to 4.3%., while the market expected 4.1%, which has driven the further bull market steepening of the U.S. Treasury yield curve. The market is currently pricing in at least 4.4 interest rate cuts for the rest of the year, which has pushed gold further higher and the VIX index hit a new high this year.

Classic global macro risk aversion

As the risk of recession intensified, bond yields, inflation expectations and stocks all fell. The bull market of the US Treasury 2S10S curve steepened, gold rose, and the hedging cost of US stocks rose - the VIX index soared, more interest rate cuts were priced in the curve, credit spreads widened, and the yen strengthened.

(VIX surges, credit spreads widen)

As the Japanese market entered a risk-averse mode, tensions in the Middle East were also increasing, and U.S. investors did not want to take risks by holding positions before the weekend, and risk-averse trading increased significantly last Friday. As expected, the Israeli stock market plummeted on Sunday, and Asian stock markets such as Japan and South Korea also plummeted during the Asian session on Monday.

Interestingly, the US dollar has not been sought after by safe-haven buying in this round of market, because it is the US data that has largely driven the global macro risk-averse mode, which has further driven the outperformance of safe-haven assets such as the yen and gold.

On Friday, the OIS (overnight interest rate swap) market priced the US federal funds rate in one year at 3.20%, which means a rate cut of about 200 basis points in the next year.This is classic recession pricing., because in the past, the Federal Reserve has cut interest rates by an average of about 200 basis points in the first 12 months of a recession.

(USD OIS forward pricing for a 200 basis point rate cut over the next year)

Europe has fallen behind

Recently, Goldman Sachs has cut its forecasts for European economic growth after a series of poor purchasing managers' index reports. European markets have not risen in sync with other global indices since early June., as interest rates in Europe remain high relative to other global economies and weak economic growth becomes increasingly apparent.

France also remains a drag, with the spread between French and German government bonds widening again as Goldman trader Matcham wrote this Friday.

Trump's deal fizzles

The U.S. market had risen for some time due to expectations that Trump would win the election. Stocks that performed well included: financial stocks (benefiting from deregulation or increased capital market activity), onshore producers and promoters of offshore outsourcing trends, U.S. border infrastructure builders, energy, coal and steel producers, etc.

However,Trump trades have also been unwound as Harris joins the race and Trump's odds of winning decrease. Markets don't like uncertainty, so as the odds of a Trump win decrease and the race becomes more intense, macro risk appetite is also weakening.

Comparison of the S&P 500 and Goldman Sachs Republican Victory Excess Return Basket:

Trump's election odds vs. the S&P 500:

Conclusion: Which trades are Goldman Sachs traders currently bullish on?

Finally, Lindsay Matcham said, "We are still optimistic about most of the deals we have been investing in, and these deals are also playing a role in the market crash last week." The deals he was optimistic about before include:

Buying risk premium on US election volatility via V2X (European Volatility) September/October/November futures;

Considering the risks of global economic growth, short positions in the German DAX index are purchased to hedge against tariff risks;

Short stocks exposed to EU tariffs.

In addition, Matcham currently favors the following equally effective trades to hedge against negative tail outcomes and potential Trump tariffs:

Betting on a steepening of the US 2-year and 10-year Treasury yield curve

Betting on the widening of the interest rate gap between Germany and Germany

Betting on widening credit spreads

Long Gold

Shorting oil prices

In summary, a number of market factors are driving the following:

The Bank of Japan’s hawkish stance led to a stronger yen and an unwinding of carry trades;

A new environment of bad (economic) news is the breeding ground for bad (market) news - the effects of a prolonged high interest rate environment are seeping into the data;

European risks caused by the slowdown in European economic growth will continue to be released.

(Cailianshe Xiaoxiang)