The world is facing complex economic challenges that require a careful balance between controlling inflation and supporting economic growth. Consumers are making sacrifices due to inflation, technology giants are under pressure, and global markets are unstable. As policymakers seek solutions, investors and the public will need to monitor developments to adapt to the new economic reality.

Global stock markets have recently been on the edge of chaos, chronologically coinciding with the release of a disappointing employment report in the United States. This has exaggerated the cause-and-effect relationship, with reactions to the report data being viewed as the sole factor in the new situation, sparking speculation that the Federal Reserve might lower interest rates. However, a deeper analysis reveals a more complex picture – key causes of the decline are linked to specific investment tactics and global economic changes, particularly in the technology sector, rather than a single isolated report.

Investor reactions to employment reports often seem exaggerated, highlighting that the stock market does not always reflect the real economic picture. Current employment reports appear to be just one of many variations. The market often signals a recession that does not materialize, as evidenced by numerous previous recession predictions that did not come to fruition.

One of the main factors is the phenomenon known as “carry trade” – a strategy where investors borrow money in a currency with a low interest rate and invest in assets denominated in a currency with a higher interest rate, allowing for greater returns due to the interest rate difference.

In carry trading, investors borrow money in a currency from a country with low interest rates, such as Japan, which traditionally has very low or even negative interest rates. The borrowed money is then converted into a currency from a country with higher interest rates, such as the US dollar, and invested in financial instruments or assets that earn interest in that currency. Investors earn on the difference between the interest rate on the borrowed money and the interest rate on the investment. For example, if the interest rate in Japan is 0% and in the US it is 5%, the investor can earn a 5% return minus transaction costs and potential currency risk.

Currency risk is a major risk in this strategy because if the currency of the country with a high interest rate depreciates relative to the currency of the country with a low interest rate, profits may be reduced or the investment result may be negative.

Regarding the current market situation, everything functioned well until there was a change in Japanese monetary policy. The Bank of Japan increased its benchmark interest rate in March for the first time in 17 years and announced another increase at the end of July, signaling the end of the era of ultra-low interest rates in the Land of the Rising Sun, making carry trades less attractive. The yen strengthened against the dollar, reducing the profitability of this trading strategy, and as investors pulled back, markets reacted with declines.

This raises questions about what to expect in the field of monetary policy, particularly concerning the US. The Federal Open Market Committee (FOMC) now has several options—they could opt for an immediate reduction in interest rates, similar to what they did in March 2020 due to the pandemic, or they could wait until the regular September meeting and decide on a larger cut than the initially announced 25 basis points.

What the wider public often does when interpreting sudden shifts in the stock market is to place such phenomena in a political context rather than a detailed market analysis, especially when it comes to the technology sector.

American technology giants such as Apple, Microsoft, Alphabet, Meta, Tesla, Amazon, and NVIDIA have an increasing influence on market trends compared to other factors due to their share of returns in stock market indices. The fact that market performance is not tied to political events is a good sign for the health of the market economy. For instance, technology sector companies, many of which were not favored by Donald Trump during his presidency, recorded excellent business results during that time. We can observe a similar trend now with Joe Biden, who is not particularly favorable towards oil companies, yet these companies are performing well. In other words, investors can achieve profits regardless of the president’s political preferences.

However, what has definitely impacted the markets is how businesses across various sectors have experienced the trend of adopting artificial intelligence solutions, as concerns about overestimated demand for specialized chips and servers have also burdened sentiment. Consequently, NVIDIA, which briefly became the most valuable company in the world this year, lost more than 25% of its value from its record high in June.

Despite the sharp decline, markets are recovering. Asian markets have already regained a significant portion of the lost ground, and US futures have also significantly risen after the earlier week’s decline. Although a recession is inevitable at some point, it is not expected to be triggered by recent stock market events.

Although recent events, including the employment report and changes in Japanese monetary policy, have caused significant turbulence in the capital markets, it is important to understand that these shifts are part of a broader picture and that markets have reacted to a range of factors, from specific investment strategies like carry trade to global economic changes and technological innovations. Regarding the Fed, the most likely option is to maintain the status quo in interest rate policy to avoid additional turbulence.

While short-term volatility is inevitable, the fundamental values of the market economy continue to provide a stable foundation for growth and development, and adapting to new conditions and understanding the complexities of current challenges are crucial for navigating this dynamic economic period.

When placing all this in the context of the financial picture in Montenegro, or any small country that is not immediately affected by the crisis, there is no need to fear a repeat of scenarios similar to those seen in 2008. Global markets continuously go through different phases, but unlike the great crisis of the first decade of this century, we have a significantly different situation.

Caution and active monitoring of market movements are certainly necessary, but the key parameter that becomes relevant for Montenegro, prompted by these developments, is the potential changes in interest rate policy and the costs of future credit arrangements that are expected.