Father of "Bond Vigilantes" Yardeni: Stock market may repeat 1987-style crash

Senior market and economic observer Ed Yardeni coined the term "bond vigilantes" in the 1980s, referring to investors who influence government decisions by raising interest rates out of concern for the national fiscal situation. This Monday, he stated that the current global stock market sell-off bears some resemblance to the crash of 1987, when investors were worried about an economic downturn that was ultimately avoided.

Yardeni told the media this Monday:

"So far, (the performance of global stock markets) is reminiscent of 1987. Stock market crashes basically happened in one day, which means we are in or about to enter a recession. But (in reality) there is no recession. It is actually related to internal factors in the market."

Wall Street News mentioned this Monday that the recent stock market plunge is partly due to the narrowing of the US-Japan interest rate differential, triggering a reversal in "arbitrage trading." The Bank of Japan unexpectedly raised interest rates last week, and after the Fed meeting last week signaled a rate cut, the Fed's September rate cut was almost fully priced in. The once popular "sell yen, buy dollars" arbitrage trade lost its appeal, leading investors to start converting their dollar assets back to yen. Another factor is the massive withdrawal of funds from tech stocks under the "recession trade." As concerns about a weakening US economy triggering a recession intensified, US stocks entered a risk-off mode, with funds previously invested in tech giants being withdrawn, leading to a rotation out of tech and small-cap stocks.

The fear index VIX, which measures stock market volatility, rose above 65 during Monday's trading, hitting a new high since the outbreak of the COVID-19 pandemic.

Yardeni stated on Monday: "I think the current situation is similar to the internal market dynamics of 1987. This sell-off is largely related to the unwinding of arbitrage trades."

During the 1987 stock market crash, Alan Greenspan had recently taken office as the Chairman of the Federal Reserve. He led the Fed to rescue the market by cutting interest rates, gradually lowering the federal funds rate to 1%, and injecting liquidity into the financial system, before gradually raising rates to 5.25%. Yardeni expects central bank policymakers to react to the current situation, but not to urgently cut rates. He said, "This is evolving into a global financial panic, and I think we can expect central banks around the world to respond to this."

Yardeni believes that the initial response of central bank policymakers may be to "reduce concerns about the US economy" and resist the possibility of the Fed starting a loosening cycle with a 50 basis point rate cut. However, he pointed out that after the futures sell-off on Friday and early Monday, the Fed will step in to provide liquidity, which could mean a 50 basis point rate cut.

Yardeni warns that the danger of a major market decline is that the plunge may self-reinforce and evolve into a credit crunch. "It is conceivable that this unwinding of arbitrage trades could evolve into some kind of financial crisis, leading to a recession," he said. However, he emphasized that he personally does not expect this outcome to materialize in the end Yardeni evaluates that despite the US July non-farm payroll report released last Friday falling short of expectations, "the labor market conditions remain good." "The US economy is still growing, and I think the momentum in the service sector is good. In conclusion, I believe that this (sharp drop) is more likely to be a market technical anomaly rather than a sign of a recession."