Stock market falls indicate growing problems in the financial system

Wall Street, along with other stock markets around the world, continued to tumble under the impact of rising interest rates, inflation and a slowing global economy amid warnings that conditions are created for financial market instability.

the FinancialTimes reported that its All-Worlds barometer of global stocks fell 3% on Monday, its biggest drop since June 2020 as markets were hit by the onset of the pandemic, hitting its lowest level since December this year.

Traders work on the floor of the New York Stock Exchange. (AP Photo/Richard Drew)

Wall Street’s steep declines of the past week continued on Monday with the S&P 500 down 3.2% and the technology-focused NASDAQ down another 4.3%. The S&P is down more than 16% for the year while the NASDAQ has fallen more than 25% and is now down 27% from its record high of last November.

After a massive sell-off in Asian markets yesterday, Wall Street rose slightly on the day.

Summarizing the general sentiments, Seema Shah of Principal Global Investors told the the wall street journal“By 2023, you will most likely see growth slow down very significantly, and the specter of recessions is really starting to loom.”

The global economy is moving in the same direction. There are fears of a major slowdown in China as it struggles to contain the spread of the latest COVID-19 outbreak, with exports falling to their lowest level in two years last month. There are signs of a slowdown in German and French manufacturing industries. The price of oil also fell as fears of a weakening global economy grew.

The latest phase of what the WSJ described as a “rout” began last Thursday. Prices had risen sharply the day before following assurances from Federal Reserve Chairman Jerome Powell that the central bank was not considering a 0.75% increase in the bank’s interest rate.

But then the reality of continued Fed rate hikes – Powell indicated that hikes of 0.5 percentage points each were on the table for at least the next two Fed meetings – crumbled and markets have fallen sharply.

Beneath the immediate swings in stock markets, there are indications of growing problems in the financial system. She is haunted by the March 2020 meltdown at the start of the pandemic which saw the Fed step in to the tune of around $4 trillion, becoming the backstop for all areas of finance.

These fears were highlighted in the Fed’s semi-annual financial stability report released on Monday. He said there was a “higher than normal” chance that conditions in US financial markets would suddenly deteriorate.

“Further negative inflation and interest rate surprises, particularly if accompanied by a decline in economic activity, could adversely affect the financial system,” the report said.

A sharp rise in rates “could lead to increased volatility, stress on market liquidity and a sharp correction in the prices of risky assets, potentially leading to losses at various financial intermediaries” which could reduce “their ability to raise capital and to maintain trust”. of their counterparts.

The Fed report says banks remain well capitalized “but some money and bond market funds are still exposed to significant liquidity risks.” He warned that some types of money market funds remained prone to panics and that “many bond and bank mutual funds continue to be vulnerable to redemption risks.” In other words, they may encounter liquidity problems when a large number of investors decide to withdraw their money.

He noted that high inflation and rising interest rates could have far-reaching effects, negatively impacting “domestic economic activity, asset prices, credit quality and financial conditions.”

Should near-term risks materialize, he continued, “and particularly if such events precipitate a marked deterioration in the economic outlook, their effects could be amplified by financial vulnerabilities” within the system.

The Fed report noted that since the end of 2021, there has been a tightening in the US Treasury securities market. Markets are considered liquid if traders can transact without affecting the market as a whole. Low liquidity, on the other hand, can amplify volatility and lead to unexpected financial tightening.

“In extreme cases, such as the market turmoil at the start of the pandemic in March 2020, low liquidity can impair the ability of the financial system to respond to a large shock, as investors may not be able to adjust their asset holdings to increase cash flow or risk coverage, or they may only be able to do so at substantial cost.

While the deterioration in liquidity had not been as extreme as in past instances, “the risk of a sudden deterioration appears higher than normal.”

The shallow depth of liquidity, he said, could indicate that liquidity providers were being particularly cautious. “Dropping depth in times of increasing uncertainty and volatility could lead to a negative feedback loop, as lower liquidity in turn can make prices more volatile.”

The report also drew attention to the situation currently developing in the corporate bond market, noting that heightened uncertainty was weighing on risk appetite for this form of debt. The share of new speculative-grade bonds with the lowest ratings from financial agencies was low by historical standards, but it highlighted the buildup of problems in other areas.

“[The] The share of outstanding bonds with the lowest investment-grade ratings – the so-called triple-B cliff – has risen to its highest level in two decades, suggesting that many investment-grade bonds remain susceptible to downgrading in speculative quality in the event of a negative economic shock.

Rising bank interest rates triggered a sell-off in Treasuries, with the yield on 10-year Treasuries now hovering around 3%, from less than 1% just a few months ago. [Bond prices and their yield or interest rate move in opposite directions.]

The change in Treasury yields has an effect on the corporate bond market. the FinancialTimes reported on Monday that Bank of America estimated the average price of investment-grade U.S. corporate bonds fell to just over 93 cents on the dollar.

This level was lower than the level reached during the stock market crash of March 2020 and a level not seen since May 2009, when the markets were still reeling from the effects of the global financial crisis of 2008. There are now clear indications that the conditions that produced these crises are building once again.


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Don F. Davis