Regional Variations in Volatility to Japan’s Black Monday

On Aug. 5, global equity markets declined, with Japan leading the drop at 10%.¹ The declines were accompanied by a major surge in volatility, inverted term structure and heightened implied-volatility skew.

How we got here

Volatility intensified within already-jittery global equity markets, after the Bank of Japan’s (BOJ) unexpected 0.25% rate hike on July 31, ending its longstanding zero-rate policy. The subsequent JPY appreciation triggered the unwinding of carry trades due to the less favorable differential in U.S. and Japanese interest rates.

A rise in the U.S. unemployment rate to 4.3% fueled fears of a hard landing, spurring record-setting single-day trading volume of over 70 million options contracts in the U.S. equity and index options markets on Aug. 2.

Emerging markets’ notably low-key response

On the following Monday, the emerging markets (EM) and EAFE had smaller increases in volatility and other volatility-based metrics compared to the U.S. The spread between the EM (VXMXEF) and U.S. volatility (Cboe® VIX®) indexes contracted by 8.9%, against an average spread of 0.5% over the five years ending Aug. 23, 2024. In contrast, the spread between the EAFE volatility (VXMXEA) and VIX indexes rose to 11.9%, compared to an average spread of 2.5% over the last five years.

Given that markets had been pricing a soft-landing scenario, these divergent reactions could be due to investors’ reassessing expected market returns across different regions. Another explanation could be EM’s lower economic exposure² to the U.S .and Japan, the economies facing the largest potential macroeconomic changes.

Although market volatility has declined sharply following the BOJ’s ruling out further rate hikes amid ongoing market instability, should the BOJ resume rate hikes and volatility reassert itself, investors may glean useful insights from the recently observed differences between regional markets.