Global stock market rout: why are stocks falling, and is there more to come?
Global equity markets have suffered heavy losses, as a cocktail of worries and elevated positioning combine to cause a significant surge in volatility.
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.
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