,Meanwhile, longer-term interest rates rose substantially in the first quarter, enough to cause investment-grade corporate bonds to suffer their worst quarterly performance since the 2008 financial crisis. Yet this didn’t trouble the Federal Reserve even as some investors worried it would derail the recovery.
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A LESSON learned after the 2008 financial crisis was that financial market shocks can turn into real economy shocks if they’re not nipped in the bud by policymakers.
That led to a decade of the public grudgingly accepting - but resenting - an environment of slow economic growth where central banks were seen as the first responders for any little disturbance in financial markets.
Now, here we are in a quarter with plenty of financial market shocks while the Federal Reserve has done nothing to step in, and yet economic-growth expectations are stronger than they were at the end of 2020.
The reason – which is a glimpse into the future for our shifting policy approach – was the trillions of dollars of spending passed by Congress that promises to expand the economy regardless of what’s happening in financial markets.
There were four distinct financial market shocks that happened in the first quarter that could have created negative spillover in financial markets and the real economy, yet none of them did. There was the epic short squeeze in the stocks of GameStop Corp and other companies favored by traders using trading platforms like Robinhood.
That led to some large hedge funds being forced to reduce the size of their portfolios, which briefly led to some broader market tremors that dissipated within a few days.
Meanwhile, longer-term interest rates rose substantially in the first quarter, enough to cause investment-grade corporate bonds to suffer their worst quarterly performance since the 2008 financial crisis.
Yet this didn’t trouble the Federal Reserve even as some investors worried it would derail the recovery. Then there’s been a deflating, if not a bubble-popping, of some high-flying technology growth stocks and special-purpose acquisition companies, or SPAC’s, since the middle of February.
The ARK Innovation ETF, one of the better-known investment vehicles in a speculative part of the market, fell 30% from its peak. This, too, failed to prompt any broader weakness in the stock market or slowdown in economic growth.
And over the past week there’s been the high-profile collapse of Archegos Capital Management, which involved the liquidation of tens of billions of dollars worth of equity positions and led to billions of dollars of losses at banks that had extended it lines of credit.
Damage has been limited to the stocks that were caught up in the selling and of the banks that suffered losses.
The reason these market hiccups haven’t been enough to dent the overall economy is that there’s so much growth happening right now – largely because of the reopening and fiscal stimulus that have muted the relative impact of financial market moves. A market stumble in an economy that’s only growing at 2% per year can create enough of a psychological impact on consumers and businesses that they pull back their spending, and before you know it 2% falls to 1%, which isn’t far from recession.