Get ready for a volatile fall in the financial markets—but not necessarily a downturn
The first global financial crisis of the twentieth century happened in 1907. The so-called Knickerbocker Crisis was triggered by the fallout from the San Francisco earthquake, a failed copper investment, and a surprise interest rate hike from the Bank of England. This crisis ultimately led to the creation of the Federal Reserve and underscored how the decisions of one central bank can impact the rest of the world. Last week, the world was reminded of this lesson, when the Bank of Japan hiked interest rates and sent markets into a temporary tailspin.
That tailspin has ended almost as quickly as it started, and new inflation data today is making the Fed’s upcoming interest rate decision much more straightforward. But it’s worth revisiting what exactly happened in the markets over the past ten days and the lessons we should take heading into a consequential fall.
On August 5, markets in the United States fell 13 percent, in part thanks to Japan’s decision but also based on signals of a cooling US labor market. Global markets have experienced jolts in recent years; In 2023 Silicon Valley Bank (SVB) collapsed, marking one of the largest bank failures since 2008.
Below is a market reaction comparison for SVB and the recent “Summer Selloff.”
Click the arrow to see more.
While the recent shock differed in many ways from the one in March of last year, two key factors set the Summer Selloff apart: the state of the US economy and the situation with Iran.
One of the main reasons the VIX (the stock market’s expectation of volatility, sometimes called the fear gauge) spiked to historic highs last week was the risk of Iran’s retaliation and a wider war in the Middle East. As more serious talks of a ceasefire deal emerged during the week, markets started to recover quickly. But the situation is shifting day-to-day.
In the United States, markets were worried that the Fed was reacting too slowly to what was happening in the jobs market. In February 2023, right before SVB, the United States was adding 300,000 jobs a month, beating all expectations. But last month’s report was under 115,000 jobs.
The Fed typically convenes eight times a year, but the summer schedule means there will be a notably long seven-week break before interest rates are revisited (absent a highly unlikely, and based on current conditions unnecessary, emergency meeting). This time gap could heighten market anxiety that the Fed is falling behind the curve and further erode confidence among businesses and consumers. While the Fed has signaled that it is preparing to cut rates in September, it is also aware that the meeting takes place six weeks before the presidential election, putting even more scrutiny than usual on its decision making. Federal Reserve Chair Jerome Powell has been clear that the election will in no way impact the Fed’s decision making.
This morning, the Fed’s decision was made easier. The consumer price index increase data came in lower than expected, at 2.9 percent, which strengthens the argument for a rate cut when the Fed meets next month. In fact, some market participants think the Fed will cut by 50 basis points (bps), or half a percentage point, not its more standard 25 bps move.
Compare the situation in the US economy now to the one during SVB’s collapse.
When SVB was unfolding, countries around the world knew they could rely on US growth to stabilize the global economy. Forecasts for the economy were high and labor data was strong. Today, US growth is slowing (forecasted to be under 2 percent in 2025), China’s economy is stalling, and Europe remains stagnant.
That explains why the market reacted the way it did last week—but what about the rapid recovery? All of last week’s losses have since been recoupled. In short, markets came to their senses.
True, the Fed does not meet for another month, but Powell will be giving one of his biggest speeches of the year at the Jackson Hole Economic Symposium in a little over a week. The annual central banker retreat brings together financial leaders from across the world’s largest economies to discuss the ongoing economic issues and policy challenges. Powell’s speech is the perfect opportunity to signal the Fed’s intentions to cut rates and cool markets.
Meanwhile markets realized that while the United States is indeed slowing, it is still growing and far from a recession. Today’s inflation data confirms that the Fed—and the broader US economy—still have a very real chance of sticking the “‘soft landing” by hiking rates enough to tame inflation without causing a recession, an outcome that would be far outside the historical norm.
The bottom line is that between an election, the threat of conflict, and a slowing economy, there is likely to be more volatility in the months ahead. But volatility doesn’t necessarily equate to a downturn—it just means there’s more uncertainty than usual.
Josh Lipsky is the senior director of the Atlantic Council GeoEconomics Center and a former adviser to the International Monetary Fund.
Alisha Chhangani is an assistant director with the Atlantic Council GeoEconomics Center.
This post is adapted from the GeoEconomics Center’s weekly Guide to the Global Economy newsletter. If you are interested in getting the newsletter, email SBusch@atlanticcouncil.org
At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.
Further reading
Mon, Aug 5, 2024
Behind the market turmoil: Why a bad jobs report and the risk of war are shaking the financial world
New Atlanticist By Josh Lipsky
A geopolitical crisis and disappointing economic news at the same time create a haze that can make each situation appear more threatening than it actually is.
Mon, Aug 5, 2024
Monday’s market rout is a painful but fundamentally healthy correction
New Atlanticist By Hung Tran
The global market selloff has been driven by the normalization of outsized expectations for the high-tech sector and one-way betting for low Japanese interest rates and yen exchange rates.
Fri, Jul 26, 2024
What French economic policy may look like after the Olympics
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The snap parliamentary election in France produced no absolute majority, and negotiations on government formation have begun. As Macron’s centrists attempt to construct a broad coalition, what economic policies can they suggest to bring the center-left and center-right onside?
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