Will financial fear drive the world into recession, or is there something policymakers can do to restore stability to global markets?
That’s the big question that hangs, unanswered, after a week in which bearish sentiments seemed to take over Wall Street and other stock markets around the globe.
The widely watched Standard & Poor’s 500 index of US stocks as of Thursday had fallen for five straight days, and is down more than 10 percent since last April. Over that same 10-month stretch, European shares have fallen more than 20 percent and emerging-market stocks more than 30 percent.
Behind the most recent turmoil is rising worry about the health of the global economy – but the real problem may be what President Franklin Roosevelt once called “fear itself.” The climate of worry could drag the economy down if shaky markets cause companies and consumers to freeze their spending plans.
Economists say there’s no reason things have to play out that way. A slowing China doesn’t mean a collapsing China. The economies of most other emerging markets aren’t imploding, either. And the dive in oil prices, while devastating to nations reliant on that industry, by itself shouldn’t smother growth worldwide. Usually it’s the opposite – a spike in oil prices – that helps bring on a recession.
Still, economist Ed Yardeni, who runs a New York area investment strategy firm, says investors are more worried now than at other rough patches since the last recession.
“Many were traumatized by the financial crisis of 2008 and are waiting for the other shoe to drop. They fear that something is bound to blow up in the credit markets, the way Lehman [Brothers] did, leading to a global financial contagion,” Mr. Yardeni wrote Thursday in a note emailed to clients. “The risk is that we talk ourselves into a recession.”
Or, as he puts it, the concern is that other shoes may drop, such as ripple effects from tightening credit markets.
Against all this, central banks and governments are trying to take actions to bolster economic growth or stave off panic. But it’s a tricky task, as some of the strategies are hard to implement or can make policymakers look desperate rather than reassuring.
Fiscal stimulus, such as government spending or tax cuts, is one option. Some nations have some leeway to do that, but in many others this option is constrained by already-high levels of public debt, or by political divisions.
A global agreement to seek stability in currency markets is another option, which finance ministers from the Group of 20 nations may discuss when they meet in China later this month. The challenge here, too, may be to bridge divisions among participants who don’t agree on which currencies have become too high or low.
Another tactic, appealing to some of the harder-hit emerging markets, is imposing “capital controls” to slow the exit of foreign investment money. The aim is not to boost growth directly but to help stop a downward spiral from getting worse. Azerbaijan in January announced a 20 percent tax on some transactions in which foreign currency leaves the country. Such moves don’t make investors happy, but rattled economies may sometimes do better despite damage to their open-market reputation.
Beyond those ideas, the International Monetary Fund is urging both developed and advanced nations to engage in “structural reforms” designed to boost economic growth – such as with policies that can expand the base of workers and entrepreneurs. Many economists back these ideas, but the efforts tend to bear fruit over the long run rather than right away.
Last but not least, monetary policy is suddenly back in the spotlights. Central banks are nimble. They’re able to respond quickly to changing conditions. A challenge now is that they’ve already been keeping interest rates very low (to encourage growth) for years. So adding more stimulus often means going an unconventional route such as “quantitative easing,” in which the central bank buys up bonds in a bid to bring down long-term interest rates and flood markets with easy credit.
The latest unconventional twist is called “negative interest rate policy,” or NIRP. The idea is to make banks actually pay something (rather than earning interest on their money) when they deposit excess reserves with the central bank. In theory, puts extra downward pressure on interest rates that businesses and consumers pay when they borrow, beyond what a zero interest rate would do.
Japan took the NIRP plunge on Jan. 29, following in the footsteps of Switzerland, Sweden, and the European Central Bank. And Federal Reserve Chair Janet Yellen said her policy team is keeping the idea in the potential US toolkit.
"In light of the experience of European countries and others that have gone to negative rates, we're taking a look at them again," she told senators at a congressional hearing Thursday. "We wouldn't take those off the table, but we have work to do to judge whether they would be workable here.
Meanwhile, just a change in tone from a central banker can help. In her congressional testimony, Fed Chair Yellen acknowledged that recent volatility in things like oil prices and currency markets has surprised policymakers. Translation: It could be a while before any further monetary tightening takes place.
Following the Fed’s modest boost in short-term interest rates in December, it now looks possible that 2016 will be free of rate hikes for the whole year – or at least until the global climate brightens.
Yellen’s messaging was intended to signal some comfort that the Fed is on the case, paying attention to financial-market distress.
By itself though, her words didn’t quell the market unease. And more broadly, negative rates are meeting with mixed reviews. Some policy experts welcome the creative effort, while others see NIRP as a sign of desperation that may hurt the economy by crimping bank profits.
One possible scenario is that fear subsides without lots of policy response being needed, as investors gain fresh confidence that the recession scenario won’t come to pass.
A solid report on monthly retail sales in the US, released Friday, is a reminder that consumer activity in most of the world hasn’t turned negative.
“We expect the Fed to begin raising rates again in June, as it becomes clear that neither China nor the US is headed for recession and, consequently, the current bout of financial market turmoil subsides,” the firm Capital Economics said in a research report Friday.
US and European stocks rose about 2 percent Friday. Oil prices also made a welcome swing in an upward direction, rising some 11 percent
Friday on hopes that OPEC nations may act to curb a supplier-damaging glut in production.