Beware! The previous "trigger for the crash" may strike back again!

In a report last Sunday, Ed Yardeni wrote that closing out arbitrage trades that shook the market last month remains a threat.

For this market veteran, the 4.3% drop in the S&P 500 index last week made no sense, as the Fed was preparing to ease monetary policy. Instead, another factor may be at play.

"Why are stock prices falling when the Fed is preparing to lower interest rates to avoid an economic recession and prevent an increase in unemployment by promoting economic growth? We saw the answer in early August: arbitrage trades are still reversing," Yardeni wrote.

In recent years, this popular trading pattern has allowed investors to borrow Japanese yen at low prices and take advantage of the country's ultra-low interest rates. Yardeni stated that these funds were then redeployed into higher-yielding assets, especially U.S. tech stocks.

However, when Japan tightens interest rates, arbitrage trades become ineffective, as was the case in August. An unexpected 15 basis point rate hike by the Bank of Japan forced traders to sell assets to cover additional margin requirements, leading to a sharp drop in the U.S. stock market on August 5.

Although the market has since regained lost ground, major U.S. indices fell again in the first week of September, with the S&P 500 index posting its largest weekly decline since the collapse of Silicon Valley Bank in March 2023.

The blame is generally attributed to last week's employment report, as weak labor force data sparked concerns about an economic recession. Despite the data released last Friday being weaker than expected, the key figures were only slightly below expectations, with a slight decrease in the unemployment rate. Yardeni believes that the market's reaction to the data is just a brief growth scare. Yardeni said in another report:

"Our assessment of last Friday's employment report is that it was not as bad as widely believed. Furthermore, some obvious weaknesses in employment suggest that productivity growth may continue to surprise on the upside."

In this scenario, Yardeni said that another factor contributed to the recent sell-off: Bank of Japan Governor Haruhiko Kuroda made hawkish rate comments.

Last Tuesday, the Bank of Japan Governor confirmed that if the Japanese economy and prices meet the central bank's expectations, the bank will continue to raise interest rates. That day, the yen strengthened against the dollar. Kuroda also stated two weeks ago at a parliamentary hearing, "Short-term interest rates in Japan are still very low. If the economic conditions are good, they will rise to what we consider a neutral level."

Shortly after the arbitrage trade sell-off in August, Morgan Stanley also warned investors that only half of the arbitrage trades had been closed out