Strange things have been happening in the world economy and financial markets this week. While that sentence could be written almost any time in the past five years, since the outbreak of the global financial crisis, the strangeness this week has taken a particular form that reveals more than it confuses.
Almost all the economic news recently has been favorable, or at least better than expected. U.S. home values have risen more than at any time since 2006, job losses are down and consumer confidence has been restored to pre-crisis levels. Japan has enjoyed its fastest growth in years, with evidence mounting of stronger consumption and rising wages. Even in Europe, the outlook appears to be improving as policy shifts away from austerity and toward growth, with the European Commission no longer pressing governments to hit their deficit targets. Meanwhile, the European Central Bank hints at the possibility of negative interest rates and other extraordinary stimulus measures. But financial markets have reacted to all this good news by becoming more volatile – panicky, even – than at any time this year.
Although the U.S. stock market briefly hit a record high on Tuesday, prices quickly slumped. Meanwhile, Japanese shares have suffered their steepest fall since the 2011 tsunami. Most importantly, bond markets have collapsed the world over, pushing long-term interest rates in the United States, Japan and much of Europe to their highest levels in more than a year.
What is going on? The clues are provided by the last market upheaval, the one in interest rates and bonds. Plunging bond markets have spooked equity investors because share prices are related in one way or another to the yields on U.S., Japanese and European bonds. And fears about volatile interest rates and wild stock market gyrations could soon infect consumers and business decision-makers in the non-financial world.
These fears raise three questions. What is causing the sudden financial anxiety? Are these worries justified? And should policymakers do anything to calm the markets, or alternatively to break the link between gyrating financial markets and the non-financial economy of consumption, business investment and jobs?