Investors are exaggerating the risks of a meltdown in the global economy, but their fears could become a self-fulfilling prophecy if central banks fail to contain the fallout, economists have warned.
A sell-off in global stock markets gained momentum on Monday as traders worried that the US Federal Reserve was taking too long to cut interest rates in the light of last week’s weak jobs data, while the Bank of Japan was setting too bold a course towards tighter monetary policy.
Economists said the extreme market reaction — with volatility reaching its highest level since the onset of the Covid-19 pandemic — was accentuated by other factors, including worries about China’s economy, a fading of the “Trump trade”, and waning hopes of an AI-driven growth windfall.
Many also said it was a necessary correction in markets that had been too blasé about the US economy’s ability to withstand such a long period of tight monetary policy.
“We were in a weird situation with a market which had clearly started to think that the US economy would never land, with either a hard or a soft landing . . . At some point this was always going to crack,” said Gilles Moëc, chief economist at Axa Investment Managers.
The Fed’s benchmark federal funds rate remains deep in restrictive territory, at a 23-year high of between 5.25 and 5.5 per cent.
So far, most believe that a cooling in the US jobs market, while real, is not too serious.
Economists at Goldman Sachs said a recent rise in unemployment, from 3.7 per cent at the turn of the year to 4.3 per cent in July, was “less dangerous than past increases” because it was largely due to temporary lay-offs and the challenges new immigrants faced in job-hunting, with demand for labour still solid. They think the risks of a US recession have increased but still see it as no more than a one in four possibility.
Ian Shepherdson, at the consultancy Pantheon Macroeconomics, called attention to ISM data on the US services sector released on Monday, saying it pointed to resilience in business activity and hiring and “should ease fears that the economy is nosediving”.
“A bumpy soft landing still looks more likely than a hard landing,” said Krishna Guha, vice-chair of Evercore ISI. However, he cautioned that the risks of a sharper slowdown in US growth had increased.
The big worry now is that if the volatility in markets continues it will itself start to hit business confidence and tighten credit conditions — with effects rippling out beyond the US to other developed and emerging economies.
Guha said broad market turmoil and a widening of credit spreads “could push firms to increase lay-offs”, while Simon MacAdam, at the consultancy Capital Economics, said the market turmoil “could itself have macro implications either because it topples major financial institutions or because . . . there is a general tightening of financial conditions”.
Kallum Pickering, chief economist at the investment bank Peel Hunt, said a “hugely broad-based, sudden confidence shock” could spill over into the real economy, adding: “These expectations can become self-fulfilling.”
These effects would not necessarily be confined to the US, though economies on the other side of the Atlantic are in a different position.
Pickering said that while investors had previously been too optimistic about US growth, they were still too pessimistic about the outlook for the UK and Eurozone — and showed no signs of a reappraisal.
However, Bill Diviney, economist at ABN Amro, said that while the Eurozone was “in a different place to the US”, that did not mean Europe would be immune to a possible US recession.
Central banks should be able to contain the fallout by verbal reassurance for now, economists said — including at this month’s gathering of global policymakers at Jackson Hole.
Jason Furman, a Harvard professor and former White House economic adviser, said on the social media platform X that even if the Fed had made a mistake in leaving its benchmark interest rate on hold last week, it was “largely inconsequential”, especially since the central bank’s dovish messaging had led to lower market rates.
As markets moved to price in 50 basis-points’-worth of rate cuts in September, economists downplayed calls for emergency action ahead of US rate-setters’ next vote.
“If the Fed did an emergency cut, that would communicate panic,” said Ernie Tedeschi, an economics professor at Yale and a former chief economist at the White House Council of Economic Advisers. “What they need to be communicating right now is calm.”
