Wall Street's fear index is down. Why does Deutsche Bank see the risk of a summer crisis?

The fear index on Wall Street has fallen to the levels of late March, when the White House has not yet announced a sharp increase in duties for all trading partners. However, the strategist of Deutsche Bank sees several factors that can provoke volatility. Among them are escalation of the trade war, rising duties, increased inflationary pressures and fiscal risks.

Investors are increasingly worried about a possible new wave of turbulence as the height of summer approaches, Deutsche Bank strategist Henry Allen said in a note assessing the possibility of another market shock in 2025. It is published by Seeking Alpha.

The third quarter is historically characterized by the largest spike in the so-called VIX fear index, Allen notes. "Liquidity is typically low, and historically many crises have started right at the end of summer," he wrote.

The markets are relatively calm now - the VIX fear index has been below 20 for almost three weeks, which is considered a sign of relatively low volatility in the market, noted Barron's. The VIX index was also below 20 in late March, before the so-called Emancipation Day, when the White House announced increased duties on all trading partners.

- Allen cited the threat of an escalating trade war as the most likely cause of market turbulence this summer. It could stoke inflation and cause investors to rule out expectations of a Fed rate cut.

"This year, markets have shown remarkable resilience. Macroeconomic fundamentals remain strong and we see policymakers willing to adjust their line in response to market turbulence [example - Trump's decision to delay duties after the April collapse. - Oninvest]. Thus, market dynamics alone constrain policy. And as long as that is the case, a prolonged crisis in the markets would require a much larger shock that cannot be quickly offset by policy measures," the strategist writes.

In his view, there remains the possibility of additional sectoral duties - on top of those already applied to steel, cars and aluminum. Allen believes markets have not yet fully factored this risk into prices. "And, of course, people are expecting that new trade agreements may be put in place that will prevent duties from returning to the levels set on Emancipation Day," Allen added.

A sharp increase in duties in August after the postponement fits into this scenario and could trigger a new wave of sell-offs, he said.

- The second cause of market turbulence could be increased inflationary pressure, Allen said. According to him, so far there are no obvious signs that the duties have significantly affected consumer prices. However, all investors' attention will be focused on the consumer price indexes (CPI) for June and July, which may show the full effect of the duties. Keeping inflation above the target level will mean that the Fed is unlikely to move to a rate cut in the near future, the strategist states;

"At the end of the day, the labor market is still in good shape, so there's no urgency on that side to cut rates. And if inflation goes even further above target, another argument for a cut will disappear," Allen said.

- A third threat that could lead to market turmoil, according to Allen, is fears about fiscal sustainability, which are facing not only the U.S. but several other G10 countries as well, writes MarketWatch. 

Already this year, rising term premiums - the extra yield investors demand for holding longer-dated debt instruments - have pushed long-term bond yields higher in the U.S. (to 4.969% for 30-year Treasuries), Japan (3.065%) and the U.K. (5.473%). 

The rise in yields directly translates concerns about financing high budget deficits, MarketWatch writes.

- Other possible reasons that could lead to market turmoil, according to Allen, include a slowdown in economic growth as well as a geopolitical shock that could trigger a spike in oil prices.

However, he said, markets have so far managed to remain resilient amid uncertainty around tariffs and some geopolitical turmoil.

This article was AI-translated and verified by a human editor