Stock markets are reeling, but economists say don’t panic yet

U.S. stock markets plummeted Monday, with two major indexes racking up their worst day of trading in almost two years.

The turmoil continued a sudden global panic that began overnight Sunday, cratering the value of stocks, currencies, even cryptocurrencies—and raising the prospect that a broader downturn could be on the horizon, especially after a weak snapshot of the U.S. job market last week. The jobs report made the American economy look like it could be on rockier footing than previously thought and sparked bets that the Federal Reserve might have to cut interest rates sooner and more aggressively.

But economists say the stock slide is not a surefire sign that a recession is ahead. The current sell-off, they say, is the result of investors having to untangle complicated, heavily leveraged trades that have artificially boosted stock values.

All three major stock indexes fell Monday. The S&P 500 dropped 3% for its worst day in nearly two years, closing at 5,186.33. The Dow Jones Industrial Average reeled by 1,033 points, or 2.6%, to 38,703.27, while the Nasdaq composite slid 3.4%, to 16,200.08. Investors moved money out of equities and into bonds.

Global markets had also reeled, with Japan’s benchmark Nikkei 225 plunging 12 percent, its largest one-day drop in almost 40 years, after an interest rate hike by the Bank of Japan last week.

But on Tuesday, the Nikkei 225 bounced back, soaring nearly 11% early Tuesday. Other markets in Asia also rebounded, but more moderately, appearing to settle somewhat after the rollercoaster ride that started the week.

Although there’s a chance the turbulence could lead to a self-fulfilling U.S. economic slowdown, analysts and economists say it’s too soon to panic. The economy, by most measures, is still in solid shape. Americans are continuing to spend, the service sector is growing, and the stock market remains up for the year, not too far off the all-time highs it set recently.

“This is not the recession train; it’s just a good old-fashioned market panic,” said Joe Brusuelas, principal and chief economist for RSM US. “This is not a D.C.-inspired event, about a slowing job market or the Fed being behind the curve. It’s about a larger regime change, where investors are adjusting to the end of easy money globally.”

Japan for years kept interest rates negative, making it attractive to borrow money against the yen to invest in higher-yielding assets such as tech stocks. But the Bank of Japan last week raised interest rates to 0.25 percent and suggested that it would continue, causing the yen’s value to spike against the dollar and sending ripples through the global economy. Most immediately, that led to a sell-off of tech and artificial intelligence stocks, including darlings such as Apple and Nvidia, which some investors had been buying up using the proceeds of trades in cheap yen. Analysts have repeatedly warned about bloated valuations well before the Japanese move.

“Investors have gotten so used to the stock market only going one way that now people are suddenly realizing, ‘Oh, stocks can also go down?’ ” said Torsten Sløk, chief economist at Apollo Global Management. “This is a situation where one weak data point—Friday’s jobs numbers—brought the bears out of hibernation.”

Fresh data on Friday showed U.S. employers added 114,000 jobs in July, far fewer than expected. The unemployment rate, meanwhile, rose to 4.3 percent, its highest level in almost three years, raising urgent questions about whether the Fed was keeping undue pressure on the economy by keeping interest rates at a 23-year high.

The central bank last week left borrowing costs unchanged, saying it needed more proof that inflation was reliably under control. Many expected the Fed to begin cutting rates at its next meeting in September.

But lackluster jobs data, combined with the global rout, quickly changed the picture. By Monday morning’s sell-off, critics were not only concerned that the Fed would have to ramp up the size of its September rate cut but also wondering whether the bank might trigger an emergency move before then.

The bar for that kind of intervention is high: The last time Fed officials changed rates between official policy meetings was at the start of the pandemic, when the economy was in free fall. Plus, the constant refrain from central bankers is that they don’t react to a single data point or sudden jolt to the market. Rather, they are supposed to look through little ticks up or down and give enough time for the data to tell a comprehensive story.

On CNBC on Monday morning, Chicago Fed President Austan Goolsbee said the central bank’s role was to help the job market, keep prices stable and maintain financial stability. So far, the economy has been able to not only withstand the Fed’s inflation fight but stay strong overall, the stock slide notwithstanding.

“We’re forward-looking about it,” Goolsbee said. “So if the conditions collectively start coming in like that on the through line, there’s deterioration on any of those parts, we’re going to fix it.”

Either way, the Fed is now expected to roll back borrowing costs multiple times before the end of the year. Goldman Sachs predicts three cuts—one each at meetings in September, November and December. Although the investment bank recently raised its odds for a recession—to a 25 percent chance in the next year, up from 15 percent—its economists note “the data look fine overall and we do not see major financial imbalances.”

The view that the market panic was disconnected from the economy was broadly shared among many Democratic policymakers and at least some Biden administration officials. They pointed to a series of reasons to doubt the latest report as a signal of a deteriorating economy, particularly the relatively high percentage of Americans who are still working.

The administration has been silent on the Wall Street panic. So far, none of President Biden’s top surrogates on the economy—Treasury Secretary Janet L. Yellen, White House National Economic Council Director Lael Brainard, or White House Council of Economic Advisers chair Jared Bernstein—had publicly addressed the market sell-off as of Monday afternoon, although experts say that is likely to change in coming days should the decline continue.

“A couple days of alarming market developments are not going to necessarily fundamentally change the economic message from the Biden administration or the Harris campaign,” said Tobin Marcus, head of U.S. policy and politics at Wolfe Research and an economic policy staffer to Biden as vice president during the Obama administration. “But if the situation gets much, much worse in the coming days, they’ll have to respond to it directly.”

Republicans bashed Biden and Vice President Harris, the Democratic nominee in November’s election, as markets slid. “This is the Harris-Biden economy at work,” the Republican National Committee posted on X. Former president Donald Trump declared a “KAMALA CRASH” on Truth Social, the social media site he owns.

Some White House allies on Capitol Hill and elsewhere have expressed frustration that the Federal Reserve had not cut interest rates yet. The White House has been careful not to criticize the Fed or urge it to cut interest rates out of a desire to avoid even the appearance of interfering with its independence, despite the sentiment among many administration officials that the central bank should have moved earlier. Biden has sought to draw a contrast with Trump, who as president demonstrated a lack of regard for the bank’s independence and repeatedly called on Powell to cut rates. Some liberal lawmakers have argued the White House has been too deferential to the Fed, but it’s unclear whether that will change even after the market sell-off.

There was also encouraging news Monday that eased some fears that this wave of financial frenzy will spiral into something worse. New data showed that the service sector—which makes up the largest part of the economy—picked up in July, thanks to new orders and increased hiring, according to an index from the Institute for Supply Management.

“The services expansion is extremely important and should assuage fears that the labor market is quickly deteriorating,” said Quincy Krosby, chief global strategist at LPL Financial.

Still, she and others caution that tanking global markets could set off a chain reaction that leads consumers and businesses to suddenly pull back, further slowing the economy.

“The underlying economy is still okay,” Krosby said. “But this has a feel of, ‘Sell now, ask questions later.’”