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What caused the global stock market meltdown

Stocks plunged across the world Monday. Does it mean a US recession is looming?

by Nicole Narea

Global stocks plunged over the weekend amid fears that the US economy is faltering, and Monday, all three major US stock indexes were down significantly.

The Dow Jones Industrial Average fell more than 1,000 points, while the S&P 500 and the Nasdaq were both down more than 3 percent — marking the S&P 550’s biggest one-day drop since September 2022. The slides came after Japan’s Nikkei index had its worst day since its “Black Monday” crash of 1987, dropping 12.4 percent, and as European markets struggled as well.

The heavy losses signal that investors are rattled following reports last week showing that the US had only added 114,000 jobs in July, below expectations of about 150,000, and that unemployment had risen to 4.3 percent — higher than any month since October 2021. These numbers are not in and of themselves a crisis: The unemployment rate is still relatively low, and the underperformance in hiring isn’t catastrophic, but both have been taken as signals that the US economy might be showing some cracks.

Even though many economists projected that the US would avoid a recession after the pandemic-induced economic slump, and despite the fact that it has done so, the reports reignited concerns that a US recession could still happen, wreaking disastrous potential impacts across the global economy. On Monday, Goldman Sachs raised its odds of a recession occurring in the next year from 15 percent to 25 percent.

It’s impossible to say now how realistic those recession fears are. But it may be too early for panic. The US economy wasn’t just supposed to be good — it actually is in pretty good shape.

“There’s certainly some slowing going on,” said Matt Colyar, an economist at Moody’s Analytics. “But the foundational things that made us relatively encouraged about the US economy — those things haven’t changed.”

Is a recession coming?

The rise in unemployment “spooked a lot of people,” Colyar said, because it triggered what is called the “Sahm Rule,” apparently indicating that a recession may be near. The rule is activated if the three-month average unemployment rate increases by at least half a percentage point from its low over the prior year. It has successfully predicted every US recession since 1970.

However, the economist after which the rule is named, Claudia Sahm, isn’t convinced that the Sahm Rule will be a reliable predictor this time. The post-pandemic economy has so far defied other historical recession indicators: For example, most bond strategists polled by Reuters earlier this year said that the patterns they study have been so unusual that they no longer considered bond yield curves to be predictive.

“If the Sahm Rule were to trigger, it would join the ever-growing group of indicators, rules of thumb, that weren’t up to the task,” Sahm told the AP before the jobs report came out last week.

One reason the Sahm rule might not be as useful this time around is that the rise in unemployment isn’t being driven by layoffs but rather more people are entering the labor force. Strong growth in the labor supply isn’t necessarily a signal of a recession, Colyar said.

“[Unemployment] could keep growing,” he said. “But as of right now, the labor market isn’t flashing red as much as it’s just slowing down.”

But a bad jobs report wasn’t the only thing driving the global market selloff; so-called carry trades may have also played a big role. These trades involve investors borrowing money in currencies that have low interest rates — such as the Japanese yen or Swiss franc — and using it to buy higher-yielding investments, such as US Treasury bonds.

Because the yen has increased in value by 11 percent against the US dollar in a month, these trades are no longer as advantageous to investors. Though it’s difficult to say for certain in real-time, Colyar said that investors may be “unwinding those bets to minimize their losses” and instead putting that money in safe-haven securities such as US bonds, contributing to the Nikkei index’s crash.

Goldman Sachs has also cautioned about reading too much into recent market volatility. In its Monday analysis, the bank said that it sees recession risk as “limited,” that it does not “see major financial imbalances,” and that though it may have increased its projection on the risk of recession, there is plenty of room for the Federal Reserve to step in to protect the economy.

The Fed is expected to cut interest rates as early as its September meeting — or unusually, perhaps even before then — and that would provide relief to borrowers and businesses. Now that inflation has come down to near the Fed’s 2 percent target rate, Moody’s Analytics is projecting two rate cuts before the end of the year in September and December, involving a gradual relaxing of high interest rates. That could go a long way in calming the stock market.

“Households remain in good shape, and businesses have continued to hire solidly. And businesses and households have handled their debt relatively well,” Colyar said. “So we think that [the Fed] can unwind policy relatively slowly. … There’s some evidence that there is more resilience there than previously assumed.”