For two days the US Stock Market reacted badly to good news.
On Friday, the US received a better than expected job market report, which showed unemployment shrinking and wages rising. That should be good news.
Waiting for the interest rates to rise
The bad news for the Stock Market is that higher wages compound pressure on the US Federal Reserve to raise interest rates, so as to tame inflation and prevent the economy from overheating.
The fear in Wall Street is justified.
Interest rates are rising from historically low levels and the US Federal Reserve has signaled three rate rises in 2018, beginning in March. Given a decade of ultra-low interest rates, the prospect of a rise triggers the kind of fear that comes with regime change.
On the one hand, rising interest rates mean that US Treasury bonds are likely to pay better maturities, without the volatility of the Stock Market; in fact, all kinds of so-called “fixed income” assets will be performing better. Therefore, pension funds, insurance companies, and other institutional investors could take their money out of the Stock Market.
At the same time, surging interest rates means the end of an era in gigantic mergers and acquisitions, which generate massive returns for stakeholders and managers. Perhaps, the time for easy money may be gone.
And if that is true, or perceived as true, markets panic. Bottom line: as interest rates rise, stocks lose a big part of their value. Faced with the prospect of a hard landing, markets are fixated on “sell, sell, sell” narrative.
fear, fear, fear
That fear was evident on Friday, February 2, when the Dow plunged by 666 points, which many were certain was truly a beastly number. The panic compounded to hysteria on Monday, with a massive selloff that triggered a 1,600 point drop for the Dow (4,6%), which is the steepest drop in history for a single trading day.
That was no longer a US fear.
Hong Kong links its currency to the US dollar. Europe feared the knock-on effect on its exports and its interlinked capital markets. Australia feared a drop in the prices of commodities, once again, just as they were steadying on a recovery track. And a number of emerging and highly dollarized economies feared the cost of servicing private and public debt issued in US dollars. The selloff went global, that is, from Hong-Kong to South Africa and from Australia to Frankfurt.
Thus far US inflation has not reached – let alone surpassed – the 2% inflation target set by all developed economies’ central banks. That is no doubt a relief for the man who should be managing this crisis in US capital markets, Jerome Powell.
The incoming Chair of the US Federal Reserve was only sworn in on Monday and could only watch from the sidelines.
On Tuesday, February 6, it was the member of the US Federal Reserve board, James Bullard, who weighed in the crisis. Bullard made the case that a buoyant labour market does not necessarily mean inflation. In a speech delivered in Lexington Kentucky, Bullard argued that the link between higher wages and inflation has been undermined over the last few years.
And as the market rebounded later in the day, President Donald Trump stepped into the conversation to provide reassurance: “our long-term economic fundamentals, which remain exceptionally strong,” the US President said. Donald Trump has seen 70 Dow records break since his election, celebrating each one as a personal achievement. Many noted that he was less keen to step in and claim responsibility for the selloff.