If you’ve recently glanced at any financial news headlines or even your own investment accounts, you know that global financial markets are currently experiencing some dramatic swings.

Markets, including equities, bonds, and commodities, are highly volatile, with Japan and the United States at the forefront.

But what’s causing these fluctuations, and what might it mean for the future? Let’s break it down and explore potential outcomes. What’s Happening in Japan and the U.S.?

Japan and the ‘yen carry trade’ dilemma

Japan’s economy, traditionally known for its stability, is now dealing with significant challenges, and is a large reason for the global selloff in recent days.

Investors are nervous about potential changes in the Bank of Japan's long-standing negative interest rate policy. The Bank of Japan last week raised interest rates by a quarter point, prompted by rising inflation and higher energy costs that are putting pressure on the economy.

This uncertainty prompted a lightning-fast unwinding of the yen carry trade. For years, investors have borrowed the yen currency at extremely low interest rates to invest in higher-yielding assets abroad. With the potential for rising rates in Japan, the cost of these trades is expected to increase. As a result, investors have been quickly unwinding their positions to avoid losses, resulting in Japanese stocks seeing their worst day since 1987. This sudden reversal has caused significant capital movement out of global markets.

U.S. market volatility

In the United States, concerns are mounting that the Federal Reserve’s high interest rates, implemented post-pandemic to control rampant inflation, might cause the economy to fall into recession.

This has led to fluctuations in the bond market, with yields reacting to new economic data, including recent labour statistics that showed 114,000 jobs added in July, well below the 175,000 expected.

Additionally, weak earnings from major tech giants have raised expectations that the Fed will be forced to cut interest rates at its next meeting in September—or even sooner. Critics argue that the Fed is moving too slowly to ease rates. Possible outcomes

The big question on everyone’s mind is how this will all play out. There are a couple general scenarios that we could see:

1. Short-lived impact with no material changes

In the best-case scenario, the current economic disruptions in Japan and the U.S. could be short-lived. For instance, incoming U.S. data over the next couple of weeks could quell concerns of a recession and the U.S. Federal Reserve could wait until September to begin its easing cycle.

Similarly, if Japan's economic indicators improve, the Bank of Japan might delay any drastic policy shifts.

2. Challenges persist longer term, leading to immediate bond yield decreases

If economic issues persist, we could see more urgent policy responses with a dramatic impact on Canadian mortgage rates.

A worsening economic picture in the U.S. could lead the Federal Reserve to take more urgent action. This could mean a larger rate cut at the next meeting in September, or potentially an emergency rate cut before then—something markets are increasingly betting on.

This would likely cause a drop in U.S. bond yields, which, given the close connection between our economies, would also lower yields in Canada. Over the past few weeks, Canadian bond yields have already fallen sharply to two-year lows.

Since bond yields influence fixed mortgage rate pricing, this could result in a further drop in fixed mortgage rates, benefiting mortgage shoppers and those facing renewals.

If you’re one of those who will be facing an upcoming mortgage renewal, be sure to reach out to a mortgage professional. They can provide guidance, help you understand your options, and secure the best rates and terms tailored to your needs.