The crash of global stock markets during the previous week was one of the most anticipated corrections. However, what came next could come as a greater surprise. The stock market of China plunged approximately 8.5 percent on Monday and this decline cascaded across Asia. Wall Street prepared itself for another session of brutal losses and London saw stocks plunge by 2.8 percent during the early hours of trading.
There are several causes for this widespread decline, but the main reason is China. The economic growth engine of the Asian economic powerhouse is sputtering and for those who are not aware, China is responsible for approximately half of the global economy’s growth in recent years.
Aside from that, the economic recovery in Europe also stays slow and though US economic growth moved forward, it can still be considered more moderate than past recoveries have led investors to expect. Meanwhile, low global demand points to lower prices of commodities, which are beating down the economies of emerging countries.
It also appears like the Federal Reserve is ready to hike interest rates soon and on top of all that, the majority of stock markets were at alarmingly high valuations before the turbulence started. Therefore, market corrections were perhaps overdue.
The issue here is that when a market correction starts, investors tend to get too carried away.
Governments of countries haven’t got much to do to help, but to avoid implementing measures that could only make things worse. For example, in the case of China, its government initially employed huge scale intervention measures that would support its collapsing stock market and then stepped back. This has resulted in confusion and left investors and traders wondering about the Chinese government’s intentions—will the government set a floor or not?
Besides that, the monetary policy of the Asian nation has also been difficult to interpret. It remains a mystery to investors and analysts, whether the devaluation of the yuan is an ad-hoc attempt to boost exports or it marks the beginning of a more market-oriented monetary policy.
In my opinion, the right policy should decrease market volatility by clearly stating intentions and avoiding unwanted surprises. Furthermore, the government should not defend rates or prices that are fundamentally misaligned. Once the thinking of policy makers has been well-understood, I believe markets will soon stabilize.
As for the Federal Reserve and its interest rates, I would say that it isn’t the responsibility of the US central bank, or any other central bank for that matter, to prop up the stock market. If the market correction exacerbates and gets in the way of the Fed reaching its targets, the central bank must not hesitate putting off increasing interest rates.