August was a busy month with markets that became very busy quickly. But now, looking back, it’s easy to wonder if all that fuss was worth it. Did the markets just have a moment of, well, drama? Here's a look at the chaos, the cool-down, and what it means for rate cuts, recession fears, and, of course, your portfolio.

Rate cuts are met with rate hikes.

The Federal Reserve hinted at a possible rate cut in September, which made July 31 feel like another Wednesday. The Bank of Japan, not to be left out, gave a hawkish nudge to its interest rate, defending the yen. Reaction? Nah. Stock prices nudged up in Japan and the US, but the world didn’t seem particularly shaken.

Fast forward to Friday, August 2. Some dismal job numbers in the US triggered the ominous Sahm rule, known for signaling recessions, after the yen had taken off. On Monday, the S&P 500 had fallen 6% and Japan's Nikkei 225 had fallen almost 20% Yikes! Suddenly, the word “recession” was on everyone’s lips.

Market Meltdown to Miraculous Recovery

Fast forward a few weeks, and things looked rosier. The US stock market rebounded, regaining ground lost since the July 31 Fed meeting, and Japanese stocks followed suit. Everyone took a collective sigh of relief as the Fed ignored cries for an emergency rate cut. Paul Krugman, among others, had suggested that cutting rates would calm nerves, but in hindsight, the Fed's inaction may have been a blessing in disguise.

Now, let’s look at probabilities. Back in early August, the chances of a September rate cut seemed nearly certain at 85%. Fast forward to today, and that probability’s down to just under 25%. Quite the mood swing, huh?

How Big Moves Make Exaggeration Real

If you’re scratching your head wondering why the August drama unfolded this way, you’re not alone. August is notoriously thin when it comes to trading volume, with many investors on vacation. Just like gossip, thin markets exaggerate the buzz, creating big reactions over little news. In 2022, a paper by the Bank of England showed how small trades can cause big changes in small markets. This is called exaggeration central.

A few disappointing job numbers and the yen's movements fuelled hopes that a US "soft landing" (no recession) was beyond reach. Ironically, markets overreacted by using one data point—unemployment—while disregarding other labor metrics that weren’t quite as grim.

What to Expect from the Fed?

Now, here’s the real question: What will Fed Chair Jay Powell do at the Jackson Hole summit? With inflation cooling and unemployment data stabilizing, Powell is likely to take a “steady as she goes” approach, steering clear of any panic-induced rate cuts.

But some Fed officials, like Mary Daly and Raphael Bostic, have hinted at gradual rate reductions. Powell, though, is no fan of surprises and likely won’t jump into anything drastic. After all, central banks hate admitting they overcorrected, and cutting rates by half a point in September would scream “oops.”

UK’s New Monetary Voice: Professor Alan Taylor Steps In

Meanwhile, across the pond, the UK is about to see some changes. Professor Alan Taylor from Columbia University is stepping up as a new member of the Bank of England’s Monetary Policy Committee. His predecessor, Jonathan Haskel, had a hawkish stance, so he is expected to take a slightly dovish approach.

Taylor’s experience during crises leans towards softening shocks rather than tightening too quickly. But he’s likely to take a more balanced approach as the UK deals with its own economic uncertainties.

Good News in the Grocery Aisle

Finally, a bit of good news for your pocket (and pantry). Grain prices are dropping because of bumper harvests. Inflation could ease, helping out less fortunate households and countries that rely on food imports.

August proved that thin markets can make mountains out of molehills. The lesson? Let the dust settle and remember that markets have a flair for drama, but not always accuracy.

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