Financial markets are more afraid of interest rate hikes and energy crises than even war, as these factors trigger fears of a looming recession. This conclusion comes from the “Fear Index” for stock markets, co-developed by economist Dr. Jan Jakub Szczygielski from the Kozminski University.
What Causes the Most Fear in Financial Markets?
The greatest sources of fear for financial markets are rising interest rates, energy price shocks, and unexpected crises that signal a possible recession. This insight is based on research by Dr. Jan Jakub Szczygielski and Dr. habil. Lidia Obojska from Kozminski University, in collaboration with Dr. Ailie Charteris from the University of Cape Town in South Africa and Dr. Janusz Brzeszczyński from the University of Łódź. Their study, published in Research in International Business and Finance, introduces the “Fear Index” for stock markets.
The index, developed by economists, analyzes Google search queries related to recessions to gauge anxiety levels in financial markets. Their findings show that recession-related fears from the start of the war in Ukraine until September 2023 were comparable to the fear levels seen during the COVID-19 pandemic outbreak in March 2020 and even during the global financial crisis of 2008–2009. This was determined by analyzing Google searches for the term “recession.”
Dr. Szczygielski explains that fear of an economic crisis significantly influences investor decisions, as well as the actions taken by central banks and governments in key global economies, including G7 nations. “Fear is the unseen factor driving critical decisions. The higher the fear level, the lower stock market returns and the greater the volatility. When investors are afraid, they lower their expectations for future cash flows and become more risk-averse. As a result, they demand higher returns due to the increased risk premium,” he notes.
Interest Rate Hikes and Energy Crises Scare Markets More Than War
The researchers found that it was not the war itself that caused the greatest fear but rather the subsequent, unexpected events. The financial markets and investors reacted most strongly to interest rate hikes, particularly in key economies such as the United States. A significant surge in recession fears also followed the attack on the Nord Stream gas pipeline, which fueled concerns over soaring energy prices. Why? Because such events and decisions often signal an impending recession and economic slowdown.
“Energy price changes and interest rate hikes had the biggest impact on recession fears. These phenomena reduce demand and lower real household income,” Dr. Szczygielski points out.
The economist explains that unexpected events are far more stressful for investors, leading to sharper spikes in recession fears than events they can anticipate. “Moreover, there is a potential domino effect: when a key economy raises interest rates, fear of a recession can spread globally,” he adds.
Spillover Effect: Central Banks Must Coordinate Interest Rate Decisions
The researchers from Kozminski University warn about the risk of crisis spillover, which can occur if central banks raise interest rates without coordinating their decisions. “If G7 governments do not coordinate their inflation-fighting strategies, the negative impact on the global economy could be greater than anticipated. Central banks should exchange information about their plans to raise interest rates,” says Dr. Szczygielski.
He illustrates this phenomenon with an example: “If the U.S. raises interest rates by 75 basis points and Germany is also considering an increase, they should not raise rates by the same amount. Since the German economy will already feel the effects of U.S. rate hikes, a smaller increase of, say, 25 basis points might be more appropriate, as part of the impact is already imported from the U.S. market.”
The key takeaway from the study is the necessity for better coordination in monetary policy tightening. “Interest rate hikes in the U.S. exert a strong influence on international markets, particularly G7 countries such as Japan, the UK, Canada, Germany, France, and Italy. All these economies reacted to U.S. rate hikes by raising their own rates. The global spillover effect amplifies monetary tightening beyond initial expectations. It’s not just about individual countries’ decisions but also their reactions to U.S. policy. This is why coordination is crucial—central banks need to consider the monetary policies of key economies to avoid excessive global economic slowdown,” Dr. Szczygielski explains.
Economic Background: What Happened in the World Since 2021?
The researchers analyzed market reactions to global events from December 2021, when Russia escalated its demands on Ukraine, to September 2023. During this period, successive crises heightened fears of a recession. Oil price shocks and abrupt monetary policy tightening often signaled an impending economic slowdown. After Russia invaded Ukraine in February 2022, oil prices soared, and the conflict triggered a sharp rise in the prices of wheat, fertilizers, metals, and energy—natural gas and coal reached record highs. As a result, inflation surged to unprecedented levels in the U.S., Europe, Brazil, and Turkey, driven by reduced consumption, low interest rates, supply chain disruptions, and rising costs of energy and food.
To curb inflation, 75 central banks worldwide decided to raise interest rates. The aggressive actions of the U.S. Federal Reserve heightened expectations of an economic slowdown. Following the U.S., central banks in Germany, France, and Brazil also raised rates, further intensifying fears of a global recession. Additionally, weak economic recovery in China contributed to the overall negative outlook. As a result, the world entered a period of heightened uncertainty, with energy crises, high inflation, and tight monetary policies deepening recession fears.
About the Study
The researchers used Google search data from December 2021 to September 2023, applying an established methodology for internet-based economic studies. The method focuses on English-language search results, as English remains the global business language. “Using machine learning, we developed a daily recession fear index based on Google searches. This index isolates recession-related concerns from general stock market uncertainty. We analyze the evolving impact of recession fears on stock markets using an advanced statistical method—wavelet coherence analysis—that distinguishes between positive and negative associations,” explains Dr. Szczygielski.
Source: CEO.com.pl
