The last 24 hours have seen a wave of sell-offs on global stock markets. Is there cause for concern? Yes, but there is also a need for some perspective and there is no reason to believe that a global economic recession is imminent or inevitable.
The cause, ostensibly, is a reaction to higher-than-expected wage growth in the US. That leads to the concern that interest rates could rise quicker than otherwise anticipated, as US authorities look to address inflationary pressures in an economy that is growing fast and has very low unemployment.
Subsequently, if rates rise in the US, they will rise around the world. The era of ‘cheap money’, which has lasted for the past decade – and underpinned a long economic upswing – could be over.
That generates additional uncertainty and concern over financial flows and a possible eventual hit for the real economy. Consumers and businesses around the world have got very used to a ‘new normal’ of cheap money and low inflation.
There are several important points to bear in mind.
Firstly, stock prices in the US have been at record levels and were already prompting some fears that they were overpriced. A downward correction of 6% to 8% may create a floor, if investors take the view that a correction of that magnitude leaves stocks priced where they should be.
Secondly, we are in the middle of this latest adjustment and it may take a few more days to work through, for the markets to ‘settle’. Rebounds and ripples may be temporary. We just don’t know (obviously).
Thirdly, the global economy looks relatively strong and is not facing an immediate major shock – such as a problem with liquidity in the banking sector, a crisis of unsustainable sovereign debt in the Eurozone or a sizeable commodity price shock. The long economic upswing since the last global recession does not appear to be in imminent danger of a major reversal.
Rather, we could be seeing an orderly adjustment that signifies some tightening of monetary conditions.
As the IMF said in its global economic update last month: “A financial market correction could be triggered, for example, by signs of firmer inflation in the US, where the boost to demand will exert downward pressure on the already very low unemployment rate. Higher inflation pressure, together with faster Fed policy rate tightening than anticipated in the baseline, could contribute to a larger decompression of term premiums in the US, a stronger US dollar and lower equity prices.”
So, no need to worry then?
Not quite. Volatile markets are always grounds for concern and any sell-off takes place with uncertainty on where the market floor really is. Sentiment can change quickly. Structural problems may yet turn out to be serious.
One analyst in London has voiced concern about high ‘margin debt’ levels. If investors borrow to invest in a booming stock market, that’s fine when prices are moving up and interest rates are low. If rates rise and the assets they are borrowing to buy are falling in price, there’s a potential double whammy. Confidence is key. Knock-on effects with serious real-world consequences cannot be ruled out.
Keep an eye on China, which is already in the midst of an official drive to slow the economy and tighten credit. The Chinese economy is a lot more important in global terms today than it was ten years ago. If the Chinese stop spending, the consequences will spread far beyond Asia.
However, stock market falls could turn out to be an overdue ‘correction’, bubble deflated and business, more or less, as usual. How far and how quickly will interest rates actually rise? Will investors’ jitters ease?
The next 24 hours will see signs of a steadying ship – or not.
This article originally appeared on just-style’s sister site, just-auto.