U.S. Market Crash : Plausible Causes & Effects
In 2018, Christmas literally turned red for the Wall Street as the colors of indices changed in accordance to that of the festival. In just seven sessions from 13th December till 24th December, Dow Jones lost over 2800 points. While half of the financial community blamed the Trump administration for this crash, other half held the Federal Reserve responsible. If the entire series of events are analyzed, both sections of the community are correct. While Fed’s decision to hike rates set things in motion, President Trump’s open and blunt disagreement to their decision added fuel to the embers.
How Fed’s Decision triggered the crash
December 2018 became a disastrous month for the investors of the American markets. All three premier American Indices slid by almost 9% with the worst hit coming on Christmas eve session. The market was strongly rooting for a neutral announcement from the Federal Reserve, and the investors were seeking a soothing tone for 2019 but when Fed announced otherwise, the stock market took a sharp dive.
If you compare market trends in the past Fed meetings, market’s crash in December 2018 was the worst since February 1994. The market was expecting Fed to keep rates neutral for the near future but the announcement to continue hikes on an auto pilot mode triggered the selling.
The immediate cause for selling was Fed’s decision to raise rates while some sections of the economy were still struggling. 2019 rate hike plan only added more pressure and investors instantaneously changed gears and started panic selling.
Did the rate hike by Fed came too early
Some experts suggested that the Fed’s decision to hike rates was also immature and was taken too early. Neel Kashkari, the president of the Minneapolis Fed and the man who ran the bailout program during the last financial crisis, had strongly urged Federal Reserve to take a pause at raising rates. As per experts, U.S. economy is still tackling numerous challenges and needs more time to gain strength. Hiking rates in this scenario would only add pressure to the economy, and hence, the general concensus that Fed’s decision was immature.
The recent hike would further drag the housing and auto sectors down as both are interest sensitive. Both the sectors are already tackling the rising input costs due to prolonged trade war and now with even higher rates, experts feel the demand will be hit substantially. Another aspect of this equation is the fear of recession. Hiking rates early would immediately start a chain reaction of a dip in demand resulting in job cuts, lesser pay and in turn push the economy closer to a recession.
Trump- Fed face off
Another reason behind sustained selloff seems to be the tussle between President Trump and the Fed Chairman. A day before Fed announced the hike and its 2019 plan, President Trump had tweeted telling the Fed not to hike rates. “I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers. Good luck!” This was the tweet shared by President Trump on 18th December morning.
Post the dreaded announcement by Fed, disappointed that his words did not change the outcome, President again wrote, “The only problem our economy has is the Fed.” President went further and questioned Federal Reserve’s understanding and competence and tweeted, “ They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders. The Fed is like a powerful golfer who can’t score because he has no touch – he can’t putt!”
While the assault of tweets was on the fore front, a rumor emerged that President was considering firing Federal Reserve Chairman Jerome Powell. This became the second pressure point for the stock markets as they went tumbling down.
Like a story has multiple angles, there is another side to the selloff fiasco. While Fed played its part in turning down market demands, Trump administration only added to the chaos. On one hand, there were rumors of the President firing Fed Chairman, and on the other, Secretary of the Treasury, Steven Mnuchin released an odd statement which only added to the nervousness.
Mnuchin on 23rd December released an unusual statement wherein he informed that he spoke to the CEOs of the country’s biggest banks. He further wrote that the executives had assured him that the banks were in a good shape and had ample liquidity to lend to consumers and businesses.
The statement did not solve anything; rather it only raised eyebrows as to why Mnuchin spoke to the banks suddenly. Reacting to the statement, experts stressed that these types of announcements only raise the question of whether the Treasury sees problems that the rest of the market is missing. They further added that such closed-door talks among Treasury, Banks and Financial Regulators on a Sunday only cause panic and fear among the investors.
The statement only added to the chaos as people rushed to exit financial shares in anticipation of a possible issue that the Treasury has already identified. It is because of this panic selling that Banks and Financial Shares saw a sharp decline in the short trading session of 24th December.
Other reasons responsible for the Selloff
Adding on to the investor concerns is the partial shutdown of the federal government. U.S. Federal government has not been operating since 22nd December and with the partial shutdown entering its eleventh day, the fear of economic slowdown is only growing. The fight over the issue of funding for the construction of The Wall on U.S. borders with Mexico is the main reason for the shutdown.
The inability of lawmakers and President Donald Trump to put politics aside to enact a budget is unnerving to investors. In a research note, Goldman Sachs said, “The confusion and disorder surrounding this week’s spending debate suggests fiscal deadlines in 2019, including the debt limit deadline which we expect to fall between August to October, could be more disruptive than they have been since the 2011-2013 period.”
While most experts feel the standoff is now close to its end but if the partial shutdown continues, the economy will have to pay a heavy price. If the impasse drags into late January or beyond, it could cause noticeable damages to the federal workers’ productivity, might even result in a delay in their paychecks, closing of national parks, suspending federal funding for loans and delay in tax refunds.
As per Mark Zandi, Chief Economist of Moody’s Analytics, if the partial shutdown continues till the end of January, then the country’s GDP will lose almost $8.7 billion. Economist Jesse Edgerton of JPMorgan Chase also predicts that the shutdown could trim growth by a half a percentage point. With all the triggers in the past, it is imperative for the U.S. administration to get hold of things and do away with this shutdown before the problem becomes too big to solve.
The overall picture of U.S. Economy
Even though the markets have reacted quite sharply to every single event happening in the last one month and the fear of a possible economic slowdown is increasing, U.S. economy still holds a lot of mettle. Indeed, there are a lot of variables which may or may not come into play and add further pressure on the economy; but there are also some green shoots which could help stabilize the road ahead.
Over the years President Trump may have faced a lot of opposition through his actions and words, but he has also laid the foundation stone to some of the key changes within the economy which truly can change the grim scenario ahead.
Despite a slight slowdown in GDP growth numbers for the third quarter, U.S. economy grew by a solid 3.4 percent. Trump administration’s $1.5 trillion tax cut package has been the primary reason behind this net growth. The tax cut package has improved consumer spending and is expected to sustain the same in the coming year as well.
Despite his long-standing cold war with the biggest American business houses over increasing domestic production, the face of American job market is slowly reviving. His threats to the business houses to increase domestic production and boost employment may look like misuse of power, but it has got the job done. Over the last 2 years, the country’s unemployment rate has been close to 4%, a huge fall from 5.6% in 2014. The unemployment rate now is at a record low and there has been significant growth in the number of new jobs. Also, the newly imposed restriction on visas has helped protect the skilled American workforce against their cheaper immigrant counterparts which in turn has resulted in improving the overall average salaries across the country.
For any economy to grow, improvements in consumer spending is an essential element. A steady job market ensures the growth in consumer spending which in turn fuels demand and economic growth. For U.S., consumer spending accounts for more than two-thirds of the overall economic activity. Hence better consumer spending would literally mean a better economy. As per the latest third-quarter data, consumer spending increased at a 3.5 percent rate.
Rise in corporate post-tax profit
Aided by the reduction in corporate tax, business houses have witnessed a rise in their post-tax profits. In the third quarter, after-tax profits rose at a rate of 3.5 percent as compared to an estimate of 3.3 percent. During April- June quarter, after-tax profits rose further by 2.1 percent, hence showing significant improvements on a quarterly basis.
Level playing field for U.S. companies
Even though the trade war with China has been one of the biggest concerns for the U.S. economy but it has also made the Global Trade fair. By increasing duties on products coming from China, President Trump has given the American manufacturers and suppliers ample support to fight against cheap imports, thus providing them with an opportunity to improve their sales.
Rise in inventory investments
Normally when a country’s inventory increases, it signals towards a worrying scenario; however, when the inventory increase is backed up by a rise in inventory investments, it means the businesses expect the demand to pick up again. In U.S. inventories have increased at the rate of $89.8 billion, but at the same time, inventory investments have also shot up. Inventory investments added 2.33 percentage points to GDP growth. This has been the biggest contribution since the fourth quarter of 2011.
Cutting down on costs
Despite President Trump wanting to build an expensive wall along the U.S. border, there are certain areas where he is looking to cut back on unnecessary spending. For U.S., defence is one of the biggest expense areas but now with the President aiming to cut down on the arms race between U.S., China, and Russia, the country’s expenses are expected to come down. There are also reports that President Trump is stressing hard on plans to cut back on defence spending in his fiscal 2020 budget. The money saved from excessive defence spending is expected to flow back into the economy, thus adding strength to it.
There might have been multiple factors which caused the sudden selloff in the stock markets, but this scenario may not sustain itself in the coming days. It has been observed that whenever there is a state of confusion and chaos, markets tend to react sharply to every single event. Similarly, U.S. markets also ended 2018 stuck in between the cross fire of political and economic events, but one can still see a silver lining to the dark cloud. Fear of a possible recession is always there but the strong positives in the equation cannot be ignored. Even though things look extremely shaky for U.S. markets right now, the economic momentum of the country is still strong and is expected to continue.