At first glance the wild gyrations in global markets over the past 10 days appear to have been driven by increased fears of US recession and of the Federal Reserve having been caught napping. Weak labour market data together with gloomy survey evidence on the state of the country’s manufacturing induced weakness in crowded and exuberantly valued areas of the US equity market such as tech. In short, an army of momentum traders was drastically wrongfooted by extreme volatility in thin August markets.
Yet the recession fixation borders on perversity given that the economy was growing at 2.8 per cent in the second quarter and that a weaker labour market is a precondition for the achievement of the Fed’s 2 per cent inflation target. That reminds us that one of the hazards of data-dependent monetary policy — Fed speak for steering by the rear-view mirror — is constant overreaction to new data releases.
A more fundamental point behind sky-high volatility is the relative monetary policy shift between the US and Japan. While Fed chair Jay Powell has clearly signalled that a rate-cutting cycle will begin in September, his Japanese opposite number, Kazuo Ueda, shifted policy aggressively last week. In addition to raising the policy rate, he indicated that there was more tightening to come.