CROSSROADS  – February 7, 2018

A new external shock to the world economy happened. The US stock market has suddenly turned southwards yesterday after a sustained period of climb.

A chain of sympathy followed across capital markets in other countries and will likely continue as the day moves on.

The next few days will be marked by wide movements of equity markets across the world as central bankers and economic policy-makers make their adjustments and try to assuage fears.

Shock or new, added uncertainty. The US Dow-Jones index plunged by 1,175.21 points, representing a fall of 4.6 percent, to close at 24.345.75 points. The volatility of the index was marked by the wide range of 5,100 index points during the day’s session.

By mid-day Tuesday trading (Manila time) of the equity markets across Asia, the Nikkei in Tokyo tumbled by 6.7 percent. The fall of other markets was further reflected in Seoul (2.6 percent), Hong Kong (4.9 percent),

Shanghai (2.1 percent) and Sydney (3.65 percent). Certainly, the day will be one of great nervous tension in the capital markets across the world.

For the Philippine market, anticipation of the policy developments, especially after the passage of the US tax reduction incentives, caused the PSEi to fall sharply last week. This was followed by a 2.2 percent fall of the index to 8,516 points at the close on Monday.

It was only at the end of last month when the PSEi was soaring at a peak of 9.058 percentage points. By 1:26 p.m. of Tuesday, the Philippine market was down another 1.93 percent, to a level of 8,449.6 points.

Causes and events.  The US developments follow a series of changes in economic policy as well as a major personnel change in the US central bank – the Federal Reserve Bank. Politics – internal US politics – is also playing an uncertain role.

The tax cut. The most important change in economic policy in the US is the tax cut law. The tax cut is designed as a stimulus for growth. Its main feature involves tax cuts that are significant for every US taxpayer, but most importantly, for US corporations.

If these tax cuts also create in their midst large fiscal deficits in the coming years, then the grist for inflationary expectations in the US economy would already induce early efforts for long term financial managers to move to safe haven investments.

A highlight outcome of the day during the market tumble was the rise in US government bonds prices because of safe haven demand. The 10-year US Treasury note is now 2.7093 percent, after rising to as much as 2.88 percent during the volatile market movements.

The Trump expectation is that this will promote growth, but if inflationary expectation is the domineering fear, the certainty of more aggressive action of the central bank could result. The Fed could, as monetary policy-maker, raise interest rates much sooner than expected.

Such action negates the growth stimulus that the government tax cut desires to promote. These shock changes could indicate a shift in fundamentals, but that is yet to be established.

It’s been essentially a nine-year bull market for US stocks, which began during the Obama years and continued during the first year of Trump. But if this sudden drop of the market is an indication, a period of caution could

New Fed chairman. A changing of the guard happened on the day when Jerome Powell took over the chairmanship of the Fed from Janet Yellen: this was the day of the big stock market plunge! The run of Yellen at the Fed had been a distinguished continuation of the programs that she inherited from the previous Fed chairman, Ben Bernanke, who was one of the most successful central bankers of his time.

Bernanke faced epochal challenges as Fed chairman that could have led to deepening collapse of the US, and consequently, of the world’s financial system during the years following the Great Recession of 2008. Had he been less gifted and insightful, one wonders where the world’s financial system would be today.

Powell’s first day in office is so intensely different from the quiet posture that has characterized his membership as Fed governors before his new appointment. His professional background is that of lawyer and his practice has been more as a private investor, though he had served as a deputy secretary in the US Treasury.

With such a powerful and important institution to head, he must have been well-vetted as an official. Certainly, given the record of President Trump’s choice of appointees in some critical offices, the world awaits to measure the new Fed chairman.

Chairman Powell will surely be tested by the rough developments that are now happening to disturb the monetary and financial affairs of the US economy. The Fed is composed of a number of regional members who will help steer the course of monetary policy. Powell might well be up to the tasks facing the institution.

Political developments. One of the major internal political developments concerns the on-going investigation of collusion between the Trump campaign and Russian interference in the US election.

This is reaching a climactic moment. The Trump government report released a House committee on security issues which appears to disparage the US Justice Department’s investigative activities.

Designed to help weaken the credibility of the Mueller investigation of collusion, any further actions that Trump might undertake to quell this investigation could blow up the political situation.

There are other threat points connected to the US political situation. Some of them relate to the North Korea nuclear problem, others to the implications on trade issues with major US trade partners.

Action at the home front: BSP? With the rapid and uncertain developments just observed, the BSP is certainly on notice to be alert on the actions to take.

This is the first important moment that the Philippine central bank faces under its new leader, BSP Governor Nestor Espenilla.

Since the beginning of the year, the anticipated movements of outflows of foreign capital invested in the country have been showing their trail in the stock market.

It is only a matter of time when the BSP will use the sharp tools of monetary policy under its command to address the existing problems.