Economists warn that investors are exaggerating risks of a global economic meltdown. If central banks do not contain the fallout then their fears will become self-fulfilling.
The sell-off of global stocks gained momentum on Monday, as traders worried the US Federal Reserve would take too long to reduce interest rates after last week’s poor jobs data. Meanwhile, the Bank of Japan had taken a more aggressive course toward tighter monetary policies.
Economists say that the extreme market response — with volatility at its highest since the Covid-19 pandemic began — was accentuated other factors. These include worries about China’s economic growth, the diminishing of the “Trump Trade”, and the waning hope of an AI-driven windfall of growth.
Many said that it was also a necessary corrective in the markets, which had been too blasé about the US’s economy’s capability to withstand a prolonged period of tight monetary policies.
“We were in an odd situation, as the market had started to believe that there would be no hard landing for the US economy. . . Gilles Moec is the chief economist of Axa Investment Managers.
The Fed’s benchmark Federal Funds Rate remains in a restrictive zone, with a high of 5.25 to 5.5 percent that is 23 years old.
Most people believe that the cooling of the US job market is real but not serious.
Goldman Sachs economists stated that the recent increase in unemployment from 3.7% at the beginning of the year to 4.3% in July was “less hazardous than previous increases”, because it was due largely to temporary layoffs and difficulties new immigrants had in finding a job, while the demand for labour was still strong. The risks of a US economic recession are increasing, but they still believe it is only a 1 in 4 possibility.
Ian Shepherdson of Pantheon Macroeconomics drew attention to ISM data released Monday on the US service sector. He said that it showed resilience in hiring and business activity, and “should ease concerns about the economy nosediving”.
Krishna Guha said that a bumpy soft land still looked more likely than an abrupt hard landing. He warned that the risk of a more severe slowdown in US economic growth has increased.
The biggest concern is that the continued volatility of the markets will affect business confidence, and tighten credit terms. This effect could spread beyond the US and reach other developed and developing economies.
Guha stated that a broad market turmoil, as well as a widening credit spread, “could force firms to increase their layoffs”. Simon MacAdam of Capital Economics said the turmoil in the markets “could have macro-implications, either because they topple major financial institutions, or because. . . There is a general tightening in financial conditions”.
Kallum Pickering is the chief economist of the investment bank Peel Hunt. He said that a “hugely wide-based, suddenly confidence shock” might spill over to the real economy.
The effects of these changes would not be limited to the US. However, economies on the opposite side of the Atlantic may have a different situation.
Pickering stated that investors were too optimistic in the past about US growth but they are still pessimistic regarding the UK and Eurozone outlooks. They show no sign of a change.
Bill Diviney is an economist with ABN Amro. He said that although the Eurozone “is in a different place than the US”, it does not mean that Europe will be immune from a possible US economic recession.
Economists say that for the time being, central banks can contain the fallout with verbal reassurances. This was also said at this month’s Jackson Hole gathering of policymakers from around world.
Jason Furman is a Harvard economist and former White House adviser. He said that the Fed’s decision to leave its benchmark rate unchanged last week was “largely consequential”, particularly since the central banks dovish message had resulted in lower market rates.
Economists have downplayed the need for urgent action before the next US rate-setting vote.
Ernie Tedeschi is a Yale professor of economics and former chief economist of the White House Council of Economic Advisers. He said that if the Fed made an emergency cut it would send a message of panic. “What they should be communicating is calm.”
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