What could trigger a late summer crisis for markets in the third quarter?

Many market crises have begun the late-summer period, as one analyst points out, outlining what could trigger turmoil in the third quarter.

Markets have already had a choppy start to the year, with US president Donald Trump's fast-moving tariff agenda and fears over the economic impact of these policies, along with geopolitical conflicts, prompting big swings in different investment assets.

Volatility in US stocks has left the S&P 500 (^GSPC) 6.5% in the green year-to-date, compared to a nearly 9.7% gain in the UK's FTSE 100 (^FTSE) in that time.

And if history is anything to go by, markets could be in store for further choppiness in the third quarter, Deutsche Bank (DBK.DE) macro strategist Henry Allen suggested in a note on Tuesday.

“With the height of summer approaching, market speculation is rising about a fresh bout of turmoil,” said Allen. “After all, Q3 historically sees the biggest spike in the VIX, liquidity is thin, and many historic crises have begun in the late-summer period.”

The Chicago Board Options Exchange's Volatility Index, known as the VIX (^VIX) or the “fear index”, represents market expectations for volatility based on S&P 500 options.

George Lagarias, chief economist at Forvis Mazars, said that September tends to be the worst month for US large cap stock returns historically, which often spreads to other markets.

“While the so-called ‘September Effect' hasn’t been fully explained, it is a well known anomaly in financial market returns,” he said.

One plausible explanation is tax considerations, Lagarias said, as before US mutual funds calculate capital gains, many managers begin to crystallise losses for tax purposes in September by selling losing positions.

“The other explanation is the ‘self-fulfilling-prophecy',” he said. “In a world that is more algorithmic, past trends are noted by algos and may tend to repeat themselves, reinforcing the tax-related dynamic that is responsible for the trend to begin with. Think of September, and sometimes October, as a reverse ‘Santa Rally'.”

Examples of previous crises during the third quarter in recent years include a weak US jobs report last August, followed by other poor data prints, which fuelled fears of a US economic slowdown. In addition, the Bank of Japan hiked interest rates at the end of July. Deutsche Bank's Allen explained that this combined “led to a big re-evaluation of the likely interest rate differentials between Japan and the US, which in turn caused the yen carry trade to unwind.”

The yen carry trade is where investors borrow money in Japanese yen, or another currency with similar low interest rates, and then use it to buy other currencies and assets with higher yields.

The unwinding of this trade led to a slump in Japanese assets, with the Topix (TOPIX100.T) falling more than 12% in a single day. This also rattled other markets and at the height of the turmoil, the VIX hit an intraday peak of 65.73 points, which was its highest since March 2020.

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Allen said that another example was in the third quarter of 2022, when markets fell after Federal Reserve chair Jerome Powell gave a hawkish speech at the annual Jackson Hole Economic Symposium in late August, followed by the US central bank delivering another 75 basis-point interest rate hike in the September. This came as gas prices surged in Europe and governments stepped in to cushion the impact on consumers. In August that year, the S&P 500 fell 4.2%, followed by a 9.3% loss in September.

Other examples Allen pointed to included 2015 when fears mounted about a Greek exit from the eurozone, which occurred alongside a sell-off in China's Shanghai Composite (000001.SS) index.

Meanwhile, stocks fell in the late summer of 2011 on the back of a dispute over the US debt ceiling and a US credit rating downgrade by S&P. This happened as fears grew about debt sustainability in Spain and Italy.

Prior to this, Allen highlighted that markets faced turmoil in the third quarter of 2008 when he said the global financial crisis (GFC) moved into its most critical phase and in 2007 when the first signs of the crisis became evident.

So, what could prompt a bout of turmoil in the third quarter of 2025?

After postponing sweeping tariffs announced on “Liberation Day” on 2 April for 90 days, Trump has further extended this deadline from 9 July to 1 August.

Allen pointed out that alongside Trump's reciprocal tariffs, there are still other sectoral duties potentially in the pipeline, with investigations underway into semiconductors, pharmaceuticals and critical minerals.

“Markets currently aren’t pricing this in at all,” he said, explaining that a number of tariff deadlines had already been shifted. And if tariffs did return in full, Allen said that they would be starting from the 10% baseline that has been in place since April, rather than nothing. In addition, he said the expectation is that further deals would be reached which prevent duties from reverting to the rates announced on 2 April.

Allen said: “While it’s reasonable for markets to be sceptical, we’ve seen a few times already where markets were surprised by how aggressive the administration were, including on ‘Liberation Day' itself (April 2), and also when Trump announced and ultimately implemented 25% tariffs on Canada and Mexico before that.

“So a sharper-than-expected tariff spike in August would certainly fit in that category and could spark a fresh sell-off.”

Rob Morgan, chief investment analyst at Charles Stanley, similarly said that so far “markets have taken a “glass half full” view of US tariffs, assuming president Trump’s bark is worse than his bite.

“But with valuations looking stretched, there’s plenty of room for a downside correction if trade negotiations — especially with China and the EU — go south.”

Deutsche Bank's Allen said that another risk is that the inflationary impact of tariffs becomes obvious, leading markets to price out interest rate cuts.

“So far, it’s not obvious that tariffs have had a major impact on US consumer prices,” he said. “There’ve been a few categories like major appliances that have seen an impact, but it hasn’t been widespread.”

However, Allen explained that it had been argued that the inflationary impact of tariffs would not be clear until June and July's inflation data, which are still due to be released.

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“This matters because a strong report means the Fed would be unlikely to cut rates any time soon,” he said. “After all, the labour market is still in robust shape, so there’s no urgent need to cut on that side of the mandate so, if inflation moved further above target, that would remove another rationale.”

Allen said two Fed rate cuts by the end of the year are still being priced in, so if those did not materialise this could prompt a reaction in markets.

Looking back at last summer, Allen said that the most important trigger for the turmoil was weak economic data.

“What was interesting about last summer’s moves was it didn’t take that much weak data,” he said.

Allen said that this shows that it could “just take a few days in a row of underwhelming data releases to ramp up those recession fears, even if subsequent data doesn’t justify it.”

“That’s particularly so given the broad optimism that there isn’t going to be a recession at the moment, in a situation where global equities are near record highs and credit spreads are tight by historic standards,” he added.

Different countries have seen the yields – which are effectively interest rates – on government bonds spike at various points this year. This means the cost of government borrowing increased, at a time when there are already concerns about high public debt levels.

For example, the yields on US government bonds, known as Treasuries, rose in May after Moody's downgraded America's credit rating. Meanwhile, last week, speculation about UK chancellor Rachel Reeves' position prompted a rise in yields on UK government bonds, known as gilts.

“The problem with fiscal concerns is market dynamics can become self-fulfilling,” said Allen. “If bond yields start to rise, that raises doubts about debt sustainability, which can trigger a further rise in bond yields.”

Neil Wilson, UK investor strategist at Saxo Markets, said: “Bond and equity markets are not telling the same story – one will have to give – either we have stronger growth and higher yields or lower growth and yields and stocks fall.”

Another potential trigger for turmoil is if a geopolitical shock causes a significant rise in oil prices, Allen said.

“Geopolitics is a factor that hasn’t really affected markets much over 2023 and 2024,” he said. “We’ve seen some brief wobbles but they’ve not been sustained.”

“But, if that changed, to the point where oil prices did see a durable increase, e.g. sustained above $100/bbl, then that would create a stagflationary shock of the sort we saw in 2022.

“That did represent a big problem for markets, because it made inflation worse, forcing central banks to hike rates aggressively, whilst growth also took a hit (particularly in Europe) given the terms of trade shock.”

The second quarter earnings season is about to kick off and as previous quarters have shown, markets have become highly sensitive to results that even only slightly miss expectations, particularly from popular mega cap companies.

Charles Stanley's Morgan said that in addition to tariff talk risks, “disappointing earnings guidance from Q2 results, or a flare-up in inflation paired with sluggish growth, and you’ve got a recipe for a bumpy ride as the year progresses.”

At the same time, Deutsche Bank's Allen said that markets have remained resilient this year for a couple of reasons.

One of which is that none of the shocks so far have created a durable change in the macro fundamentals. The other is that policymakers have shown consistent willingness to adjust policy in response to market turmoil.

“So, in the current climate, as long as markets believe that policymakers are willing and able to adjust in response to turmoil, then that in itself should limit the extent to which markets can sell off aggressively,” he said. “That means for a summer crisis to prove longer-lasting, and for the current resilience to end, it would take something that affects the macro fundamentals, but policymakers can't easily fix.”

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