Richard Adams's blog

What is Wall Street telling us?

The gyrations on Wall Street and world stock indicies may be a sign that credit markets and bank lending are tightening again
Newspaper with Wall Street in Panic headline
'Wall Street in Panic' from 1929. Photograph: Hulton Archive/Getty

Another rough day on Wall Street, with share prices falling in Asia and Europe, and the Dow-Jones industrial average slipping below the 10,000 mark. All this is in sharp contrast to financial markets just two weeks ago, and a steady stream of economic data from the US that suggests it is returning to growth. So what has gone wrong?

The easy answers are the geo-political ones: the turmoil in the eurozone in the wake of Greece's fiscal crisis and the tensions growing between North and South Korea.

The realisation that Europe's major economies will be affected for years to come is obviously going to be a drag on the US, since Europe is the US's most important export market (and vice versa, of course). US hopes for export-led growth will be hurt by the weakness of the euro, since it makes US exports more expensive for European consumers. The New York Times reports today that some analysts are predicting the euro could fall to as low as $1. Great for Americans going on holiday to Europe, and great for European companies exporting to the US, but not so great the other way around.

But while that's a valid reason, it doesn't fully explain what's going on. In fact, in at least two respects the current market turmoil looks like the bad days of the 2007-09 financial crisis and credit crunch. Market volatility is high and key money market interest rates – such as Libor, the London Interbank Offered Rates – are going higher, a sign that banks are once again finding credit difficult (as in, more expensive) to come by.

But as economic recovery has taken hold in the US and in much of Europe, central banks have been extracting themselves from the credit makets, where they have been doling out liquidity since the 2008 crisis. But the latest events mean the central banks will now have to go into reverse: hence the Federal Resreve restarting its emergency swap agreements with central banks in Europe, Canada and Japan.

And that also explains why a Fed governor last week was warning that the events in Europe would have an impact on US banks, which "might be forced to pull back on their lending, as they did during the period of severe financial market dysfunction that followed the bankruptcy of Lehman Brothers". Into this mix we can throw uncertainty over new regulations, in the US and Germany, that will affect the financial sector.

In other words, it's the incipient credit crunch, rather than Greece's crisis, that's behind the ups and downs on Wall Street.

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