What’s behind the current market turmoil?

Aug 24, 3:49 pm
Dow Jones Index - Historical Chart

There have been a lot of factors playing in investors’ minds but here’s a quick summary of the major factors that are a cause for concern and ones which could have played a role in shaping the investor sentiment to pull out of the equity markets the world over.

But first some context…

The equity markets enjoyed a stellar rally this year, and especially the US markets which has been in a bullish trend for close to six years and counting. This was largely due to an accommodative US Fed policy which, after the financial crisis of 2008 loosened its purse strings to flood the markets with cheap money. This additional liquidity has helped investors to boost the equity markets thus so far. The first chart below shows the Dow Jones Index for the past 5+ years. It is not hard to miss the strong uptrend on the chart since early 2009. If you pull up any other chart of a major equity index chances are that you will see a similar story play out.

Dow Jones Index - Historical Chart
Dow Jones Index – Historical Chart (Source: Tradingview.com)

What’s happening now?

For starters, the US Federal Reserve has signaled its intentions to start raising rates, which have been stuck at historical lows of near zero percent, but at the same time has tried to boost confidence in the markets that the US economy was able to now sustain the rise in short term interest rates. While the markets did at some point in time throw a tantrum, the markets soon stabilized and continued to rally albeit at a reduced pace.

Since early August, things took a turn for the worst as economic data from China continued to fall. Being a major player in global economy, China’s economic slowdown which was already expected since the start of this year continued to gain momentum as inflation failed to rise, alongside the GDP which was continuing to contract. The PBoC had intervened many times this year but mostly stuck to the conventional monetary policy tools of cutting interest rates and the reserve-requirements-ratio. However none of this failed to stall the markets or the economy which eventually led to devaluation in the Yuan in a bid to boost exports. However, this policy move saw wide spread repercussions as investors became aware of a slowdown that was serious in nature.

The market volatility picked up steam earlier this week but the wheels were already in motion since the PBoC’s intervention. And besides China slowdown there were a lot of other things in the markets, which incidentally led to a strong risk aversion in the markets.

To summarize the factors that could have played a role in today’s historic market flash crash…

China: The fall out in the Asian equity markets today was led by the fact that the markets expected the PBoC to cut its RRR over the weekend or indulge in some policy change, which didn’t happen. However, it would be too early to conclude as the PBoC could act at some point if the market sentiment deteriorates.

Greece: While Greece might have received its third bailout, the country is still far from the storm it kicked up. Failing to deliver on his election mandate, SYRIZA party and the Greek Premier Alexis Tsipras, facing dissent within his part has resigned last week calling for snap elections on 20th September. With the center and left wing parties now toeing the same line, it is unlikely that there will be a major disruption to investor confidence in Europe… unless of course the radical Right-Wing parties get voted into power. While Greece might not have that big of an impact in the global perspective, the Euro has shown in the past that bad news is good news. It is perhaps unsurprising to see why the Euro performed so strongly today.

Doubts on Fed rate hikes: July’s FOMC meeting minutes were dovish and led many to believe if the Fed will indeed be able to hike rates or whether it missed a window of opportunity. With inflation stuck stubbornly low below the Fed’s target rate of 2% it is unlikely to see a rate hike in September. However, questions remain on October’s hike as well unless inflation picks up strongly in the next two months.

Some analysts have been bullish amidst this market rout and have boldly predicted to buy the dips in the markets. It is widely speculated that there could some Central bank interventions in the markets at some point in time to stabilize and contain the current sentiment. While the statements might be bold and perhaps contrarian, investors will have to wait and watch how this story unfolds.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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