The swift and severe correction in risk markets was triggered by China adjusting its currency peg on August 11 (Chart 1). Many interpreted this "devaluation" as indicative of China growing more slowly than its official figures suggested.
Chart 1 | Chines Yuan (CNY/USD)
Oil and other commodity prices collapsed again, punishing producers. At the same time, the beneficiaries of lower prices are slow to spend their windfalls.
In financial markets, massive outflows occurred from equity funds, emerging markets, and high yield bond funds. By August 24, 90% of the world's equity markets were trading below their 200 and 50 day moving averages.
In the US, volatility not seen in years and a rare 10% fall in the S&P 500 Index in four days unnerved investors (Chart 2). Markets participants had been lulled into complacency by four years without a correction of 10% or more and the economy doing rather well.
Chart 2 | S&P 500 Large Cap Index
Panic comes on suddenly, especially in markets subject to abrupt moves by price insensitive sellers: risk parity/algorithms, high velocity traders, robo advisers, and leveraged ETFs. What price/earnings multiple should investors pay in markets capable of such sharp corrections?
Meanwhile, the underlying investment case remains for a long-lasting economic expansion and a consistently friendly Federal Reserve. Low growth, low inflation, and low interest rates are more likely than a recession.
Will the Federal Open Market Committee start to normalize rates at its September 16-17 policy meeting in these circumstances? It has no need to do so, other than making good on a commitment it feels it has made.
Watchful waiting may be harmless, whereas the risk of being blamed for another down leg in commodities and equities is not the way to win friends in Congress. We will know the Fed's decision soon...and whether the markets frankly give a damn.
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