In a report last Sunday, Ed Yardeni wrote that the closing of arbitrage trades that shook the market last month is still a threat.

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

"Why is the stock price falling when the Federal Reserve is ready to lower interest rates to avoid an economic recession and prevent an increase in the unemployment rate? 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 yen at low rates and deploy the funds into higher-yielding assets, particularly US technology stocks, according to Yardeni.

However, when Japan tightens its interest rates, the 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 meet additional margin requirements, resulting in a sharp drop in the US stock market on August 5th.

Although the market has since recovered some ground, major US stock indices fell again in the first week of September, with the S&P 500 index experiencing its largest weekly decline since the collapse of Silicon Valley Bank in March 2023.

The blame for last week's jobs report, which raised concerns about an economic recession due to weak labor force, is generally attributed. But despite weaker-than-expected data released last Friday, the major indicators were only slightly below expectations and the unemployment rate decreased slightly. Yardeni believes that the market's reaction to the data was only a brief growth panic. Yardeni said in another report.

"Our assessment of last Friday's employment report is that it wasn't as bad as many people thought. In addition, some apparent weaknesses in employment suggest that productivity growth may continue to surprise on the upside."

In this situation, Yardeni said another factor contributing to the recent sell-off was hawkish comments from the Governor of the Bank of Japan, Haruhiko Kuroda.

Last Tuesday, the Governor of the Bank of Japan confirmed that if the Japanese economy and prices meet the central bank's expectations, the central bank will continue to raise interest rates. On that day, the yen strengthened against the dollar. Two weeks ago, Kuroda also stated 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 neutral levels."

Shortly after the sell-off in August arbitrage trading, JPMorgan also warned investors that only half of the arbitrage trades had been closed.