It's best not to bet on the Federal Reserve's emergency intervention to save the market!

Global stock market sell-off on Monday has triggered calls for Fed intervention, with traders expecting a 60% chance of a 25 basis point rate cut by the Fed within a week, but this may bring more trouble to investors.

Analyst Simon White stated that the Fed's official mission is to address unemployment and inflation issues, but in reality, its job is to prevent a "feedback loop" between the market and the real economy, which could lead to an economic recession. The increased likelihood of an economic recession is due to market expectations of a recession being heightened by positioning, despite the U.S. economy appearing no different from last week.

White added that the Fed cannot rescue an already recessionary economy through rate cuts and balance sheet adjustments, but it is possible to prevent a recession by nipping it in the bud before the recessionary cycle forms, which is why an early rate cut is a possibility that cannot be ignored. In fact, the likelihood of a 50 basis point rate cut or more is also increasing, as in such a scenario, the probability of a larger rate cut would be higher if a rate cut were to occur.

However, market risk expert and bestselling author Lawrence McDonald stated that this "Black Monday" was not driven by a banking crisis, and the drawbacks of an emergency rate cut by the Fed outweigh the benefits, "If they do so, they will weaken the dollar, actually strengthening the yen, making the entire arbitrage trade worse."

McDonald mentioned that when the Fed raises rates, the dollar tends to strengthen, and vice versa. On Monday, the dollar fell against the yen, and the "arbitrage trade" mentioned by McDonald and others was one of the key reasons for the sell-off, related to Japanese interest rates.

Post-pandemic, the Fed and other central banks in developed markets have been actively raising rates to combat inflation. However, in Japan, inflation is more subdued, and the government has long been trying to stimulate economic growth, keeping interest rates near zero. Therefore, hedge funds and other investors can borrow yen at low rates and then purchase assets globally.

As long as the interest rate differential between the Bank of Japan and other central banks remains significant, the yen weakens relative to other currencies (such as the dollar), making this trade effective. By late July, this trade had been effective until the Bank of Japan raised its benchmark interest rate and indicated a slowdown in its bond-buying program, helping the yen appreciate and triggering a reversal in the arbitrage trade.

McDonald stated that even though the market sell-off has somewhat stabilized, a Fed rate cut may strengthen the yen and continue to pose market risks. McDonald described, "When this trend occurs, you may end up blowing up your counterparties, and it will take at least three to four weeks to figure out where the bodies are buried."

He added that if the Fed takes action, "getting hands-on" with the balance sheet may be more meaningful than directly cutting rates.