Analysis-Recession fears that the rate cut has dampened the joy in the latest market sell-off

By Naomi Rovnick

LONDON (Reuters) – Growing unease over the U.S. economic outlook and a seasonally weak month for stocks created another perfect storm of global market volatility, leaving investors scrambling for cover and fearing another round of currency chaos.

After a quick recovery in risky assets such as stocks and high-yield bonds following the chaotic sell-off in early August, traders lost short-lived optimism that US interest rate cuts would support growth.

Instead, they look set to move ahead on Friday with US jobs data likely to repeat last month’s weak report, with Tuesday’s lackluster US manufacturing data triggering fresh selling.

Wall Street’s S&P 500 fell more than 2 percent on Tuesday, while Japan’s broad Topix stock index fell 3.7 percent on Wednesday, its biggest daily decline since the market’s Aug. 5 plunge and from falling European stocks.

Meanwhile, the VIX index of expected U.S. stock volatility hit a one-month high as choppy currency trading threatened the dollar and other safe-haven currencies.

“Markets have been dealing with uncertain inflation, but growth has been resilient,” said Florian Ielpo, head of macro at Lombard Odier. “This situation appears to be changing, the new uncertainty is how deep the slowdown will be.”

SHAKEOUT

The shock start to September follows a global meltdown since early August as a Japanese rate hike and US jobs data destroyed popular carry trades betting against the yen.

Echoing the pain of August, highly valued tech stocks that have flocked to investors are taking a beating. Nvidia fell 9.5 percent on Tuesday, the deepest one-day drop in market value for a U.S. company. Dutch semiconductor equipment supplier group ASML Holdings fell about 5 percent on Wednesday.

“One of the big risks is that you have this concentration of the market and all it takes is for one of those (big tech) names to be volatile for it to spread throughout the market,” said Justin Onuekwusi, CIO at investment firm. St. Jacob’s place.

The change followed investor jitters that stocks and bonds started September with different stories – equity markets weighed in on solid corporate earnings while government debt rose on expectations of deep cuts in US interest rates and the risk of a recession.

“You have to decide now whether you like credit and bonds or stocks,” said Lombard Odier’s Ielpo, who added that he had bought government bonds in the past four weeks.

Yields on the 10-year U.S. bond, at about 3.8 percent, have fallen over the past four months. German Bund yields retreated from one-month highs hit on Monday on Wednesday.

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BCA Research recommended selling stocks and buying bonds.

“We rate a recessionary turning point high,” a client note said.

The Federal Reserve is expected to cut interest rates for the first time since 2020 on September 18, with money markets now pricing in a 43% probability of a 50 basis point cut in its funds rate to 4.5%-4.75%.

A broad index of the performance of high-yield corporate bonds also rose 2.5 percent from a brief decline in early August.

Ninety One credit fund manager Darpan Haran said he was wary of high-yield U.S. bonds sold by borrowers whose weaker financial profiles make them vulnerable to economic shocks.

“US high yield is more prone to a repricing due to valuations and US recession fears,” he said.

DOLLAR JITTER

Traditional currency havens may not shine in this global selloff, analysts said, because of uncertainty over whether the dollar will retain its usual appeal when risky assets fall or suffer, as traders believe a US recession is on the horizon.

Short-term speculators have about $9 billion betting on the dollar falling against other major currencies, a position that could trigger more currency swings if it turns out to be wrong or further weaken U.S. stocks if is correct.

The trend followed CTA funds, key players in the August market selloff, making big bets that the dollar will weaken, said Alex Jekov, BNP Paribas head of FX G10 Strategy.

If this week’s US jobs data comes out strong, the dollar could strengthen, prompting rapid exits from those short positions and hitting currencies that speculators currently favor, such as sterling.

An index of currency volatility is heading back toward peaks reached in early August.

Societe Generale chief FX strategist Kit Juckes said that in the long term, the dollar and US stocks could drag each other lower because of the large amount of funds that have now flowed into overseas Wall Street stocks without hedging currency.

“The risk to the dollar is that people are not just getting out of the dollar, they’re getting out of US stocks,” he said.

(Reporting by Naomi Rovnick; Additional reporting by Amanda Cooper and Dhara Ranasinghe; Editing by Dhara Ranasinghe and Emelia Sithole-Matarise)