The Journal. - What the Stock Market Panic Says About the Economy

Episode Date: August 6, 2024

Slow job growth in the U.S. and interest rate cuts in Japan triggered a global stock market sell off on Monday. WSJ’s Nick Timiraos breaks down how it happened, what it says about the economy, and what it means for the Federal Reserve’s long-term goal of a soft landing. Further Listening: -Live from Seattle: A Weird Economy + Election = ??  -Why the Fed Is Steering Away From Rate Cuts Further Reading: -Market Selloff Upends Fed Rate-Cut Calculus  -Lousy Jobs Report Forces Fed to Reckon With Hard Landing  Learn more about your ad choices. Visit megaphone.fm/adchoices

Yesterday was a bad day on the stock market. It has been a scary Monday for those who watch the stocks closely. Breaking news from Wall Street this morning. Right now, the Dow Jones Industrial Average is down. The Dow opened more than a thousand points lower. The S&P 500 and the NASDAQ are also down. And Japan's Nikkei plunged 12.4% today as Asian stocks tanked after new US data fanned fears of a recession.

Today, stocks have regained some of their losses. But a dip like this worries economists, because it can signal that there are weaknesses in the US economy. Where we're at in the economy is a potential turning point. That's our colleague Nick Timmeros. He covers the Federal Reserve. We've been wondering for the last two years what it would look like when the economy slowed down and now the economy's slowing down. The big question is does it slow to something that's just more normal, you kind of glide into the speed limit, or are you going to slow down and then stop? And that would be,

you know, what we've had in the past when we had a recession. So there's been all this talk for years now really of the Federal Reserve trying to achieve a soft landing, this idea that they can bring down inflation without causing a recession, that they can land the plane softly. And for a while, it's looked like a soft landing might be possible, but what is the pilot saying now? Well, the pilot's not saying anything right now, but I think the cabin just got a little bit more quiet

because you're beginning to see data that could be consistent with a harder landing. We just don't know yet. Welcome to The Journal, our show about money, business and power. I'm Ryan Knudsen. It's Tuesday, August 6th. Coming up on the show, what the panic in the stock market tells us about the economy. Pandora Be Love. What does Be Love mean to you? I definitely would say my be love role model is for sure my sister. Unconditional, infinite love. Something that is never ending, that you know is always there.

Never questioned. Never questioned. No matter if you fall off a cliff, she's there to catch you, you know? Be love. Shop now at pandora.net. ["The Last Supper"] Before the market sell-off on Monday, there was a bad jobs report on Friday. Unemployment rose to 4.3%, the highest level since 2021. This was definitely a weaker than expected jobs report. unemployment rose to 4.3%, the highest level since 2021.

This was definitely a weaker than expected jobs report. It wasn't a great report. It was a little bit lighter than expected. These numbers are adding to fears that we could be entering the earliest stages of a recession. Why do you think that happened? The unemployment rate wasn't a total surprise because if you looked at the last several months of later market data in the U.S., what you saw was the following.

More people looking for work, fewer people finding jobs, so the hiring rate has fallen. But layoffs were still very low. And so the unemployment rate continued to rise. It didn't go up because a bunch of people lost their jobs Permanently it went up because more people are looking for work fewer those people are finding work So that doesn't sound so bad though I mean even an unemployment rate of 4.3 percent isn't that high and in the jobs report 114,000 jobs were still added to the economy

So what why is that leaving people to start to think that we might be either in or at the precipice of a recession? These numbers would not be alarming if you had full confidence that we were just going to stay here, that the unemployment rate after having hit a low of 3.4% in early 2023, that it was now going to stabilize just below a half percent, that would be fine. Everybody would welcome that. The worry isn't so much the level of the unemployment rate or the level of job growth, it's the trend.

Job growth is slowing, labor demand is cooling, and there's nothing that says it'll stop here. And so that's the worry. The worry is that it'll keep rising and eventually if businesses don't need workers and they're not hiring as many people, at some point if things slow down enough, they'll start firing people.

And that's when you have a recession because you get sort of a negative feedback loop where businesses cut workers, people don't have more money to spend, so more businesses cut back workers. That's the definition of a recession. And the next thing that happened? Then all the way around the world in Japan,

the Bank of Japan raised interest rates last week, and you really began to see investors in Asia selling stocks overnight in the U.S. on Monday. Japan's decision to raise interest rates had a big knock on effect because a lot of investors were borrowing Japanese yen at low rates and using that money to buy other stuff like US stocks. That's called a carry trade. You borrow in cheap Japanese yen to buy something else.

Japanese stocks, US technology stocks. And so then when the yen strengthened against the dollar, the trades no longer were attractive to be in and people began to sell, forced to sell to get out of them. And so when you see huge market moves, like what we saw on Monday, where the Nikkei, the stock index in Japan

was down more than 12%, you know, that's a huge decline. And that's the sort of thing you see when there's this speculative unwind. How did that then trickle over to US stocks? Well, because a lot of Asian investors who had been borrowing in yen to buy stocks now had to sell something to pay back their lenders. And so what they sold was what they owned, which were these US technology stocks. When those investors started selling stocks, markets in the US plummeted. The Dow Jones Industrial Average fell over a thousand points. The Nasdaq, which is mostly made up of technology stocks, fell about 3%. Nick says the most alarming thing might have been what happened to the VIX, an index that

tracks market volatility, the so-called fear index. The fear index, it shot to a very high level, a level that you saw last during the 2008 global financial crisis or in March 2020 during the pandemic. And this was really reflecting these trades unwinding, but people said, oh my goodness, why is the VIX shooting up like this to a level that we haven't seen outside of these very unusual historic crises? What's happening right now?

Now it was short-lived, it has been short-lived, but it got a lot of attention. And it got attention because this sort of thing just doesn't usually happen in the financial market without something very dramatic going on. How is it that like the Japanese yen and this trade that was taking place and a jobs report, like how can all these things add up to people being worried that there might be a hard landing? Well, this is like a Jenga tower. The global market is incredibly interconnected and you push one thing here and you might trip something else off over there.

So if pieces are coming out of the Jenga tower, does that mean it's gonna fall over? That's next. ["The Trial of the Sun"] Embrace the summer vibes with Summersbee Hard Cider, bursting with lovely aromas of apple. This light-bodied fruity cider offers a crisp, clean finish, perfect for sunny days and warm nights. Enjoy it well chilled or over ice. That's refreshing.

That's Summersbee. Must be legal drinking age. Please drink responsibly. Carlsberg Canada Inc. Waterloo, Ontario. Go back to school with Rogers and get Canada's fastest and most reliable internet. Perfect for streaming lectures all day or binging TV shows all night. Save up to $20 per month on Rogers' internet.

Visit rogers.com for details. We got you, Rogers. So how worried should we be about all these things that we're seeing? Well, how worried should we be? I mean, I think, you know, it's a really good question. I think you take note from what the market's telling you right now, but you don't necessarily panic in response to it. And there was a little bit of panic on Monday. There's information here.

The market's telling you something, but the market isn't always 100% right either. I think what the market is saying right now is that it's possible the Fed's interest rate stance is slowing down the economy. The Fed has kept interest rates high for years now, trying to fight inflation. But investors have been watching for the moment they might decide to cut. Earlier this year, it looked like maybe inflation was cooperating so much that they'd be able to start cutting interest rates and then inflation picked back up and everybody said, well, maybe not.

Maybe we're going to stay at a higher level for longer. But high interest rates, while having the benefit of lowering inflation, can do damage to the economy, especially as they drag on. A lot of businesses will have to refinance debts. They haven't been refinancing because interest rates are so high. They're waiting for interest rates to come down. They're holding on for as long as they possibly can. And at some point, they're going to throw up their hands and lay off workers. They may go bust. And so interest rates, if you keep them this high for a long

enough time, you'll really see weakness, even though you're not seeing it yet. So the Fed watches closely for signs of weak economic data, which they certainly got with the unemployment report, that weak jobs data. But how much does a drop in the stock market really say about the overall economy? A drop in the stock market can change sentiment. If stocks are reacting to economic news, they see a slowdown. Businesses are ultimately gonna react to that same news. They might fire more people, they're not gonna invest as much.

And it's possible that businesses that fought so hard, they scrapped to rehire workers after the pandemic. They threw these kind of panic bonuses, rehiring bonuses. So they worked hard to get these people into the jobs they have now, and they're not gonna wanna fire a lot of them at the first sign of softness. So maybe they're holding onto these workers.

But if the economy continues to slow, if the stock market goes down more, like a beach ball that's being held under the surface of the pool, when you let it go, it doesn't just go up a little bit, it pops right up. And so if businesses hit that point where they say,

okay, we don't need these people anymore, and the beach ball pops up, that is hundreds of thousands of people now lose their jobs, it just, you hit that inflection point and then it happens very quickly in the economy. So the Federal Reserve has its next meeting in September. What are they likely to do? Well, remember the Federal Reserve met last week, and there was some question about whether they might cut rates last week. There were a few economists, people who used to work

at the Fed, saying, you know what, the Fed needs to cut interest rates now. But they decided not to. They want to see more progress on inflation. And so it was a little bit of rolling the dice. And then you saw the employment numbers last week and even more people said, well, I think the Fed would feel a lot better about themselves if they had cut interest rates. So their next meeting is now six weeks away in the middle of September. And the Fed chair, Jay Powell, last week was pretty clear that even before the week payroll numbers, they were prepared to cut interest rates

by a quarter point in September. So that now seems very likely to happen. And in fact, you know, the weakness that you're seeing in the economy and in the stock market, it's leading investors to wonder if the Fed might do more. What would do more involve they could cut rates by a half point at the meeting in September? That's a large interest rate cut.

It's reserved usually for situations where things are slowing down quite a bit. They could cut interest rates in between meetings. That's very rare. That's reserved for crises or situations where there's really severe deterioration. That's not something we're seeing right now. Are you hearing concerns from anybody that the Fed may have waited too long to cut interest rates? Absolutely.

After the jobs report last week, there's a lot more people saying, well, gee, it sure would have been better if they had cut interest rates last week. But hindsight's 20-20. And there were not as many people before the interest rate meeting saying the Fed needed to cut rates. So do you think the chances of a recession have increased more so now than they looked to be last week?

There are a number of economists who think that the chances of a recession have gone up not a lot, but that they now look slightly higher than they did a week ago. And really it's because of the slower hiring situation in the US labor market. So the reason the Fed has been raising interest rates and kept them so high is, of course, to fight inflation. So is that fight over? The fight against inflation isn't over. Inflation using the Fed's preferred gauge is at about two and a half percent.

They target two% inflation, but 2.5% is a lot better than where we were earlier last year when inflation was still above four and close to 5%. So it's come down a lot, and there are good reasons now to think it'll continue to come down. So you see the inflation fears aren't quite as prominent as they were 6, 12, 18 months ago.

So the last question that I have is that, you know, we've been talking about this idea of a soft landing, it looked like we might have a soft landing, now we're talking about a hard landing. Is this plane ever going to just freaking land? Yeah. I mean, I have a connection to make. gonna just freaking land? Yeah. I mean, I have a connection to make. I mean, we're getting impatient. We want to take off our seatbelts and stretch our legs. The truth is, all recessions, except for the COVID one, they started out looking like a soft landing. And you can go find a lot of newspaper articles before the

recession that began at the end of 2007 or the beginning of 2001 that said, gee, it sure looks like we're having a soft landing. Soft landings are less common, but in the few that we've had, they've felt pretty bumpy when the plane hits the ground. In 1995, when the Fed achieved a soft landing, you had a terrible bond market route in 1994. You had the Mexico peso crisis. It didn't feel soft. So I think the takeaway here is that hard landings can start out feeling soft, and soft landings don't always feel soft when the pilot is putting the wheels down on the

runway. Right, a little bit of shake. Well, maybe at some point I'll be able to clap like they do annoyingly sometimes when airplanes land. Yeah, from your lips to God's ears. Okay, great. Thanks so much, Nick. Really appreciate it. Thanks, Brian. That's all for today, Tuesday, August 6th. The Journal is a co-production of Spotify and The Wall Street Journal. If you like our show, follow us on Spotify or wherever you get your podcasts. We're out every weekday afternoon.

Thanks for listening. See you tomorrow.