Wall St. Weighs the Effect of Weaker China and Stronger U.S.

The world’s two largest economies — China and the United States — are moving in sharply different directions. Both are a risk to financial markets.

Investors are wary of China’s weakening growth, deflation and precarious real estate market, but they have largely shrugged off these concerns so far. Investors are, however, flinching at signs that the U.S. economy is unexpectedly strong, which could prompt a stronger response by the Federal Reserve as it tries to rein in inflation.

The S&P 500 stumbled on Tuesday, falling about 1 percent, extending the decline recorded this month to more than 3 percent. That pullback put a small dent in the rally for the benchmark stock index since the start of the year, which has still gained about 16 percent over that time.

The move on Tuesday came amid several signs of weakness in China. The country lowered some interest rates to try and prop up its economy, which has been under pressure from strict pandemic restrictions and then a weak recovery after lockdowns were lifted, as well as a teetering housing market causing considerable worry.

Also on Tuesday, the Chinese government said it would stop publishing data on youth unemployment, which was expected to set another record high, raising concerns about how the tightening control of information was making it harder to invest and do business in China, a major U.S. trading partner.

Janet Yellen, the Treasury secretary, warned on Monday that China’s slowing economy was a “risk factor” for the United States. But the country’s woes hadn’t altered Ms. Yellen’s upbeat outlook for the U.S. economy, she added, despite the potential spillover effects.

Some investors echoed Ms. Yellen’s sentiment, saying that the slump in stock prices on Tuesday morning stemmed more from fresh data showing the resilience of the U.S. economy, raising fears that the Fed may take more drastic action on interest rates to slow it down and rein in inflation.

Daniel Morris, chief market strategist at BNP Paribas Asset Management, called it “pretty amazing” that “the second-biggest economy in the world is having a lot of problems and that I don’t think global markets are paying much attention.”

U.S. retail sales in July rose faster than economists’ expected, according to data released on Tuesday, rising 3.2 percent from a year earlier. “This robust increase won’t comfort Fed officials and keeps the risk of tighter monetary policy very much on the table,” Oren Klachkin, the lead U.S. economist at Oxford Economics, wrote in a research note. Minutes from the Fed’s latest meeting are set to be released on Wednesday, giving more insight into policymakers’ thinking.

The retail sales data helped push Treasury bond yields higher. The 10-year yield, which underpins everything from mortgage rates to how companies are valued, touched a high for the year on Tuesday.

In Britain, which is also struggling with inflation, wage growth was higher than forecast, spooking investors.

The concerns are that interest rates may need to rise further, and remain at lofty levels for longer, if growth remains strong and inflation moderates only gradually.

Mortgage rates in the United States are near their highest levels in more than two decades, amplifying fears over homeowners’ and commercial property owners’ ability to refinance their loans. Some companies are also struggling to keep up with higher interest payments on their debt.

If high interest rates help tip the U.S. economy into recession, China’s weakness could compound the stress.

Already, weakness in China’s economy has helped push up the value of the dollar, which hurts emerging economies that rely on dollar-denominated imports like oil and food, and reduces the value of overseas profits for U.S. companies.

“If the dollar gets too strong while the global economy is on a weaker foot, the U.S. won’t be immune to the backdraft,” said George Goncalves, global macro strategist at MUFG Securities.

Mr. Goncalves warned that the full effect of the Fed’s interest rate increases to date, rising from near zero last year to above 5 percent, have yet to flow through the economy, and that could mean there are more weaknesses to come.

Some analysts urged caution about reading too much into recent market moves. August is often a choppy trading month, when many traders are on vacation and markets can swing sharply because of thinner trading volumes. Over the past week, there have been signs of investors increasing hedging positions that guard against a sudden fall in the stock market.

“August is often a perplexing month in the market,” Mr. Goncalves said. “It’s not quite crisis mode but something is up.”