The meltdown that wasn’t: 5 lessons from Wall Street’s panic attack - The Boston Globe (2024)

Lesson #1

Like young children, Wall Street doesn’t handle transitions well.

The Federal Reserve has spent the past two years fighting inflation with high interest rates. Defying expectations, it has nearly succeeded without causing a recession.

Now, central bankers are pivoting to rate cuts, probably starting in mid-September. They hope to extend the four-year economic expansion and contain the rise in unemployment before it gets much worse.

But traders, analysts, and economists are slamming the Fed for waiting too long to lower lending rates. Part of Monday’s market meltdown reflected worries that policy makers were behind the curve, leaving more time for restrictive rates to throttle consumer spending and business investment.

It wasn’t the first time investors have thrown a fit amid a change in Fed policy.

Stocks fell sharply in December 2018 when officials made the ninth in a series of rate hikes aimed at bringing borrowing costs back to levels in place before the 2008 financial crisis. A similar incident — the infamous “taper tantrum” — happened in 2013 after the Fed said it would reduce a bond-buying program implemented as an emergency measure during that same financial crisis.

Lesson #2

Economic data can flash conflicting signals at the same time.

The weakening of the job market last month triggered the Sahm rule, a measure of rising unemployment that has corresponded to the start of every recession since 1970.

But the National Bureau of Economic Research, the private group that determines when recessions start and end, considers more than just the jobless rate when making its call (usually months or years after the fact). And many of those measures — among them gross domestic product, employer hiring, personal incomes, consumer spending, and retail sales — show an economy that has cooled to what the Fed considers a more sustainable pace.

In fact, the economy has proven more resilient than the Fed could have hoped when it began hiking interest rates in March 2022 to bring down the highest inflation since the early 1980s.

GDP expanded at a respectable 2.8 percent annualized rate from April to June. Employers continue to hire in about the same numbers as 2019, before the pandemic.

Today, the central bank’s preferred inflation gauge remains above its 2 percent target, but only because it relies on a quirky estimate of home prices that no one actually pays.

Lesson #3

Nailing a soft landing — returning to 2 percent inflation without painful job losses — is next to impossible in a globally linked economy with a gazillion moving pieces.

Interest rates are a blunt tool, without a handbook for how fast or how far to raise them, or when to lower them.

Last week, after he and fellow policy makers voted to keep their benchmark lending rate at a 23-year high, Fed Chair Jerome Powell said the economy was solid and the job market was “strong but not overheated.” That, he said, gave officials the leeway to wait until they were sure inflation was no longer a problem.

But investors are an impatient lot. Powell’s willingness to roll the dice, at least until officials next meet on Sept. 17-18, stoked an underlying anxiety that the economy is living on borrowed time.

Lesson #4

Investors aren’t always rational.

Immediately after the Fed’s “no action” rate decision on Wednesday, stocks rose. The Standard & Poor’s 500 index gained 1.6 percent.

On Thursday and Friday, following a pair of reports showing the job market losing more steam, the index shed a combined 3.1 percent, leaving it down less than 1 percent for the week.

Then stocks hit the fan on Monday. The trigger: a 12 percent plunge in stock prices in Tokyo, the worst day since the 1987 crash.

The decline had little or nothing to do with the US economy — global investors were exiting a popular trade that was derailed by a quickly appreciating yen — but it rattled enough nerves that US stocks plunged when trading started in New York. The S&P 500 fell 3 percent.

Economist and New York Times columnist Paul Krugman put it this way: “Most people selling stocks and other assets weren’t engaging in macroeconomic analysis; they were selling because prices were falling.”

In other words, the biggest market rout in two years was largely the result of lemmings following each other over the cliff.

A final thought (Lesson #5)

The S&P 500 has lost 8.3 percent since hitting a record high on July 16. (It’s up 9 percent for the year.)

The retreat reflects deep doubts about the economy and tech stocks, which soared so high on the unproven potential of artificial intelligence that investors are wondering whether prices have become detached from reality.

The economy has recorded 46 months of growth, well shy of the post-war average for expansions of 64 months.

Nobody knows when the next recession will arrive. An effective rate-cutting campaign from the Fed might keep business humming into next year.

But the best way to track the economy’s health is to filter out the stock market noise and focus on fundamentals like GDP, jobs, incomes, and interest rates.

This story has been updated.

Larry Edelman can be reached at larry.edelman@globe.com.