What could go wrong?
Snarky macro commentators with misplaced pretensions to cleverness are quite fond of that question. In the context of market color, it’s almost always rhetorical, and when used as such, it’s an exhausted cliché.
That brand of “analysis” is paint-by-numbers: You juxtapose some manifestation of market optimism — typically a stock rally — with a compendium of foreboding headlines then ask, sarcastically, “What could go wrong?” You could make a career of penning content with that blueprint. And some people do.
The problem with that sort of thing — besides being unimaginative — is that it tends to gloss over the fact that financial assets aren’t generally impacted by most real-world disasters. And thank God for that. Because if the question’s “What could go wrong?” the answer’s any- and every- damn thing. Just ask 100 drowned souls in Texas.
That said, “What could go wrong?” pieces are occasionally useful, and I like to publish one in late-July to account for what can be challenging market conditions in August. It’s a little early yet to fret over next month’s seasonal, but in a new note, Deutsche Bank’s Henry Allen reminded clients that Q3 tends to be characterized by higher volatility due in no small part to thin August liquidity.
The simple figure shows you the VIX seasonal. Liquidity and vol tend to be inversely correlated, and that inverse correlation is part and parcel of sundry “doom loops” lurking in modern market structure. When volatility rises, market depth dissipates, making it harder to trade in size without moving the price. Big price moves beget more volatility, which saps liquidity further, making it even more difficult to trade and around we go. And desks are short-staffed in August.
In the same note, Allen wrote that “many historic crises have begun in the late-summer period.” I won’t dispute that, but it’d be just as accurate to say many historic crises haven’t begun in the late-summer period. Although there’s a market seasonal which helps explain why crises which unfold during summer’s dog days beget outsized moves, there’s no “seasonal” for crises. Crises can happen to anyone, anywhere at any time. Right now, there are millions of people all around the world experiencing some manner of crisis, God bless ’em.
But you don’t have to look too far back to find a late-July/early-August crisis. There was one last year, when a slow-burning yen carry unwind conspired with a short-lived US growth scare to trigger a truly harrowing 48 hours of trading which included the worst single-session Nikkei crash in history and the most dramatic VIX spike since February of 2018.
The figure shows you the high print on the VIX from the early morning hours of August 5, 2024. Remember: The VIX isn’t a “price.” Using VIX futs, the spike was nowhere near that extreme, but the point is just to remind you how “wrong” things went in early-August of last year.
“What was interesting about last summer’s moves was it didn’t take that much weak data and objectively, payrolls weren’t recessionary,” Allen remarked, recalling that fateful episode which, for a few hours anyway, had short-end traders betting on an emergency Fed cut. “But it tapped into existing fears about a slowdown, and the [worry] was that things were quickly about to get a lot worse, particularly with the Fed having kept rates on hold for over a year in restrictive territory.”
Read that last bit again. The Fed was still holding rates in restrictive territory and declined to cut preemptively at the July 2024 FOMC meeting, setting up markets to respond violently to any undershoot on the data. Sound familiar? The setup in 2025’s almost identical. The Powell Fed’s unlikely to cut preemptively later this month, leaving markets “on their own,” so to speak, for the very long stretch between July’s policy gathering and the September SEP meeting.
“What [last year] shows is it could just take a few days in a row of underwhelming data releases to ramp up recession fears, even if subsequent data doesn’t justify it,” Deutsche’s Allen went on, before suggesting the situation’s especially perilous given “global equities are near record highs and credit spreads are tight by historic standards.”
And there it is, everybody: The juxtaposition between manifestations of market optimism and the prospect of a foreboding eventuality, the classic setup for “What could go wrong?” posed rhetorically.
In this case, it needn’t be rhetorical, though. That is: You can answer it. If the question’s “What could go wrong in late-July and early-August of 2025,” the answer’s “Ask late-July and early-August of 2024.”
(The Fed should cut later this month. On that point, at least, I agree with Donald Trump.)
