September was the worst month for Wall Street since the March 2020 collapse at the start of the pandemic amid growing problems for the US and global economy.
All three major indices ended the month on Thursday with significant declines. The Dow Jones lost 547 points, or 1.6%, the S&P 500 lost 1.2% and the NASDAQ lost 0.4%. The monthly declines for the three indices were 4.3%, 4.8% and 5.3% respectively.
The fall was caused by several factors, working in combination. These include: inflation; the prospect of higher interest rates; the conflict over the US debt ceiling and the slowdown in production in China resulting from an electricity crisis.
On the inflation front, despite Federal Reserve Chief Jerome Powell’s mantra, as well as other central bankers, that the surge is due to temporary factors that will subside once economies start to shrink. recovering from the effects of the pandemic, there are growing fears that it will become permanent.
An indication of this came this week when the price of oil surpassed $ 80 a barrel amid a surge in natural gas prices.
Speaking to a House financial services committee on Wednesday, Powell maintained his position that the price hike was temporary. He expected it to reverse but gave no indication when it might happen and neither did he.
The spike in prices, he said, was “a function of supply-side bottlenecks over which we have no control. We expect high inflation to subside as we believe the factors causing it are temporary and related to the pandemic and the reopening of the economy. “
In response to questions, Powell said the Fed would find itself in a “very difficult situation” if inflation continued above the Fed’s 2% target while the economy was “far” from full employment. . If inflation eased on its own, the Fed would not have to face the “hard trade-off” of having to raise interest rates while the labor market was still weak.
But so far, there are few signs that inflation will ease. Earlier this month, the Organization for Economic Co-operation and Development (OECD) released a revised projection indicating that it expected inflation to be higher in 2021 and 2022 than it was. had planned before.
OECD chief economist Laurence Boone said inflation would present policymakers with a “difficult balancing act”.
A Financial Time (FT) on the latest OECD projections provided insight into the political economy of Powell and others’ insistence that the inflation spike is temporary.
According to the FT: “Boone said that consistent communication about the temporary nature of much of inflation would help prevent businesses and households from thinking it was right to raise prices and demand higher wages, which would prolong the duration of inflation and become more damaging. . “
There is no greater fear in major economic policy circles that the present round of prices will trigger a push for higher wages in the working class – of which there are more and more indications – to compensate for the declines in living standards that have already taken place.
Another factor in the growing nervousness of the markets is the fear that central banks might hike interest rates earlier than expected. Wall Street welcomed the last Fed meeting on Sept. 21-22 and rose even though Powell indicated the central bank would most likely announce a withdrawal from its $ 120 billion in monthly asset purchases during its November meeting.
Indeed, he insisted that any decision to raise the bank’s base interest rate to virtually zero would not take place until the reduction process is complete. But the subsequent announcement by the Bank of England that it planned to tighten monetary policy by the end of the year sparked a wave of sales.
Low interest rates and the trillions of dollars in asset purchases by the Fed and other central banks since 2008 – a process that has accelerated due to the pandemic – have fueled the market rise stock market, but there are warnings of a sudden turn of events.
Mike Lewis, head of US spot trading at Barclays, told the FT this week: “The game is going to work until it doesn’t work and when it doesn’t… I’m planning something very violent. I was able to witness a real drop in the stock market. You have had 14 years of coordinated World Central Bank accommodating behavior. “
Bond prices started to fall, causing interest rates to rise – the two have an inverse relationship. This week, the yield on 10-year Treasury bonds – a benchmark for US and global financial markets – rose to 1.55% from 1.31% a week earlier – a seemingly small increase but a sharp rise in the bond trading world.
Added to the uncertainty of the market is the conflict over the decision to lift the US debt ceiling. While a resolution passed by Congress on Thursday avoided an immediate U.S. government shutdown and provided money to most departments until Dec. 3, the issue of raising the debt ceiling remains unresolved.
This despite continued warnings from Treasury Secretary Janet Yellen that failure to do so would have “catastrophic” consequences if the US government did not repay its debt. Republicans declined to vote for the increase on the grounds that it would be an endorsement of the Democrats’ spending program. Indeed, the lifting of the cap does not authorize new spending, it simply allows spending voted by Congress.
Speaking at a business conference following his testimony before the Senate Banking Committee, Yellen said a dysfunctional Congress could pose a greater threat to the U.S. economy than the pandemic.
New York Fed Chairman John Williams warned that if no deal is reached, investors will become “extremely nervous” leading to “extreme backlash in the markets.”
The nervousness in financial markets is compounded by China’s growing financial and economic problems. While there is a general feeling that the issues surrounding the debt-laden real estate developer Evergrande may be contained – by no means inevitable – other issues are emerging.
This week, the official Chinese manufacturing purchasing managers index, an indicator of factory activity, fell to 49.6 in September. It was the first time he had passed below the 50 point mark, which marks the border between contraction and expansion, since the start of the pandemic in February 2020.
This decline is the product of severe power shortages and a slowdown in the real estate sector.
Power shortages have hit at least 10 Chinese provinces. Power companies have been unable to meet growing demand from industries due to rising prices for coal and other energy sources as well as increased costs imposed to meet emission targets of the government.
Earlier this week, Bloomberg announced that major state-owned energy companies – in coal, power and oil – had been ordered to guarantee winter supplies “at all costs” with the directive Deputy Prime Minister Han Zhen, who is in charge of the country’s energy sector and industrial production.
Chinese chief economist at Japanese financial firm Nomura, Ting Lu, told the FT that China’s electricity problems may have been underestimated due to the focus on Evergrande.
“The shock of the power supply in the world’s second-largest economy and largest manufacturer will reverberate and impact global markets,” he said.