On Monday, positive economic data in terms of employment and wages led to a somewhat perverse response from the US markets, who fear inflationary pressures from the now bullish economy will lead to a further tightening of monetary policy, and at a faster pace than previously thought.
Investors in Wall Street were quick to react, fearing an overvaluation of stocks when compared to companies’ profits and overall soundness. This asset bubble has been fueled by cheap liquidity – the norm ever since the 2008 financial crisis when policymakers slashed interest rates to near zero and artificially pumped billions of dollars into the world economy through successive rounds of Quantitative Easing, which policymakers globally are now beginning to draw to a close. This led to a sharp drop in the Dow Jones which fell by 4.6 per cent, the largest drop in a single day since 2011’s “Black Monday” when Standard & Poor’s downgraded the US’s credit rating in the midst of the Global Recession. This sentiment quickly spread across Europe and Asia who also suffered lesser, but nonetheless considerable, losses.
The White House was quick to reassure investors and the wider American public that the economy’s fundamentals remained strong, with an apparent attempt by Trump to distance himself from the market plunge. Most economists are seeing this fall in global markets as a mere correction, not a crash, with fears that companies had been artificially supported by cheap credit, which is unsustainable in the long term.
This plunge in the markets must seem like a flashback to 2008, hopefully reminding investors of the apparent risks in the markets, stemming any hubris that ultimately develops after a period of market buoyancy. The only underlying fear within the global markets is the risk of an overheating economy with unsustainable high levels of global growth, especially within the advanced economies, meaning the return of hawkish monetary policy. This has the potential, if not applied correctly, to curb the strong recovery of the economy.
Europe didn’t see anywhere near as drastic falls in asset prices because wages and inflationary pressure remain weak, giving more breathing room for central bank policymakers, in particular those at the European Central Bank. This reduces the risk of any accelerated tightening of monetary policy and suggests that high levels of monetary stimulus will persist.
Following Monday’s precipitous decline markets have become increasingly volatile and continued to tumble, indicating that this period of correction may continue for some time. Although the markets have been volatile and the current market mood appears negative, under lying economic performance is positive. It is too early to see Trump’s impact on the American economy, with the US President’s tax reform only passed a month and a half ago. The future seems bright, and unless the loose monetary policy has caused any widespread mal-investment, the long-term prospects of the world and US economies look healthy with a continued bull in markets seeming likely, albeit with increased volatility.