​​Global stock market rout: why are stocks falling, and is there more to come?​

​​​What is happening in stock markets?

​Global stock markets slumped, with Japan's Nikkei 225 plummeting 12.40%, its largest single-day drop since 1987. European markets opened lower, with major indices falling between 1.7% and 2.8%, while US NASDAQ 100 futures dropped 5%. This market rout was primarily triggered by fears of a US recession and a weak July payrolls report, while the unwind in Japanese yen positioning has caused shockwaves of volatility around the world.

​The Volatility Index (VIX) soared to its highest level since October 2022. This is a good gauge of investor concerns about the global economy. While it dropped back from the early highs, it remains significantly elevated.

​VIX chart

​Investor reactions and market shifts

​In response to these developments, investors fled to safe-haven assets, leading to increased expectations of Federal Reserve (Fed) interest rate cuts. Treasury bond yields hit their lowest levels since mid-2023, and the US dollar weakened against other major currencies, particularly the Japanese yen and Swiss franc. On 2 August, unprecedented option trading volumes were recorded, suggesting that short volatility positions are starting to unwind.

​Analyst predictions and recession indicators

​Major financial institutions have adjusted their economic outlooks, with Goldman Sachs increasing recession odds to 25% and JPMorgan assigning a 50% probability to a US recession. Several recession signals have emerged, including an increase in the unemployment rate and the normalisation of the yield curve after a long inversion period.

​Historically the ‘uninversion’ of the yield curve, when it goes back above 0, means that a recession is now likely within the year. This has been the case leading up to previous recessions, though no indicator has a 100% success rate.

​Volatility to continue for some time

​The unwinding of short volatility positions is expected to continue, potentially creating a negative feedback loop as volatility increases. Systematic traders are likely to persist in selling stocks while volatility remains high, further elevating market volatility and perpetuating another negative feedback loop.

​Will the Fed cut rates?

​Given the current market conditions and recession fears, there are expectations of significant Fed rate cuts in the coming months. This shift in monetary policy could have far-reaching implications for various asset classes and overall market sentiment.

​The Chicago Mercantile Exchange’s (CME) FedWatch tool now puts the chance of a 50 basis point cut by the Fed at 94.5%. Investors are fretting that the Fed has left it too late to cut rates to support the economy, and may now be forced into a more aggressive easing cycle to try and stave off a recession. Historically such easing cycles see poor equity market returns in the medium-term.