Posthaste: It's summertime and the season is ripe for a market meltdown
It’s summertime and the meltdowns are easy.
The third quarter can be a dangerous time for markets. Historically many of the biggest crises have started in late summer when liquidity is thin and the VIX is prone to spike.
Markets have been remarkably resilient this year, but there is no shortage of catalysts waiting in the wings, said Henry Allen, macro strategist for Deutsche Bank Research.
Donald Trump’ s trade war is set to climax on Aug. 1, the deadline for reciprocal tariffs to take effect on a host of countries. On top of that, the U.S. president has begun to announce plans for sectoral duties on such products as copper and pharmaceuticals.
“Markets currently aren’t pricing this in at all,” said Allen.
Trump’s frequent shifts and the prospect that deals will be reached before the deadline has made the market skeptical of this threat, he said.
But we have already seen the carnage that comes when investors are surprised by United States’ aggression. Stocks tumbled after Liberation Day on April 2 and when Trump slapped Canada and Mexico with a 25 per cent tariff in March.
“So a sharper-than-expected tariff spike in August would certainly fit in that category and could spark a fresh sell-off,” said Allen.
Inflation is another trigger . So far the effect of tariffs has not shown up in the United States, but it wasn’t expected to until June and July after companies had time to adjust their prices. The first of that data comes out next week.
Hotter inflation would keep the Federal Reserve on the sidelines and markets, who are expecting two more rate cuts this year, would react, he said.
A third is weak economic data and this one is a hair-trigger. Last summer the U.S. unemployment rate rose more than expected, breaching what’s known as the Sahm rule. The market reaction was swift and brutal, with the S&P 500 shedding more than 6 per cent in just three trading sessions.
Allen said what’s interesting about this sell-off was the data wasn’t even that bad, but it tapped into recession fears that had been brewing for awhile.
“For today, what that shows is it could just take a few days in a row of underwhelming data releases to ramp up those recession fears, even if subsequent data doesn’t justify it,” said Allen.
“That’s particularly so given the broad optimism that there isn’t going to be a recession at the moment, in a situation where global equities are near record highs and credit spreads are tight by historic standards.”
Growing fears about countries’s debt loads is another vulnerability. We have already seen bond yields spike this year in the United States after the Moody’s credit downgrade and in the United Kingdom last week.
The problem with fiscal fears is they can become self-fulfilling, said Allen. A rise in bond yields raises doubt about debt sustainability, which then can push yields even higher.
That’s what happened in the summer of 2011, when the United States was embroiled in a cliff-hanging debt ceiling dispute and faced a S&P credit downgrade. Concerns about debt were also rising in Europe.
The S&P 500 fell 5.7 per cent that August and another 7.2 per cent in September.
The reason markets have held up so well this year is that policy makers have shown a willingness to step in when things go sideways and none of the shocks have actually affected the economy, said Allen.
Everybody was worried about recession after Liberation Day, but when Trump extended the tariff deadline, in part because of bond market pressure, those fears faded.
To get a long-lasting market sell-off there would have to be a shock that affects macro fundamentals and that policy makers can’t fix, he said.
That happened in a summer not so long ago.
In late August of 2022, inflation was sky high and Fed chair Jerome Powell delivered a hawkish speech at Jackson Hole, followed by a third oversized rate hike in a row.
The S&P 500 fell over 4 per cent in August and 9.3 per cent in September.
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America’s effective tariff rate is on its way back up, after President Donald Trump announced reciprocal duties ranging from 25 to 40 per cent for 14 countries this week. When you factor in the Vietnam deal, the rate rises to 17 per cent, said Sal Guatieri, senior economist with BMO Capital Markets.
Though that is lower than the 26 per cent peak in early May before the China agreement it is enough to do some damage to the U.S. economy, said the economist — in the range of about half a per cent of annual growth.
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Send us your summer job search stories
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Send us your story, in 50-100 words, and we’ll publish the best submissions in an upcoming edition of the Financial Post.
You can submit your story by email to fp_economy@postmedia.com under the subject heading “Summer job stories.” Please include your name, your age, the city and province where you reside, and a phone number to reach you.
McLister on mortgages
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Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.
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