Extreme fear is haunting markets again. Here's why investors are running scared

London CNN

Investors are very nervous at the moment.

CNN's Fear and Greed Index (which tracks seven indicators of the market sentiment in the United States) tipped Thursday into 'extreme fears' for the first since March when the banking crisis caused panic among investors.

It is the painful combination of rising oil prices and expectations that interest rates will continue to rise in the US and Europe for a longer period of time, as well as a Chinese economy in a rut, which is what is making people fearful today.

The US is once again at the brink of another government shut down, which could lead to a downgrade in its credit rating, as well as volatility in US stock prices.

Michael Hewson is the chief market analyst for CMC Markets. He told CNN that rates in the US and Europe may 'well be headed for a long period of stagflation,' meaning they will remain higher and longer, and the economic growth could slow to the point we could experience a recession.

Stocks around the globe have recovered their losses after a brutal 2022. The S&P 500 Index (SPX), the Nasdaq, which is a tech-heavy index, has risen 33% since the beginning of the year. Stoxx Europe 600, a stock market index, has risen 5%.

In the last few weeks, however, cautious optimism gave way to concern. Stocks on the S&P 500 have fallen by 5% since mid-September. Nasdaq has dropped by 6%. Stoxx Europe 600 is down 3.3%.

'Higher for longer' interest rates

In an effort to curb inflation, the world's largest central banks have raised borrowing costs over the last two years.

Investors tend to prefer bonds over stocks when interest rates are high, as they are more secure. High interest rates will also cause companies to pay higher debt interest in the future. This will reduce future cash flow.

The Federal Reserve has indicated that they may increase rates again this year, and that there will be fewer rate reductions in 2024.

Fed officials are worried that the US economy is growing so strongly, they fear inflation will rise again. This means rates would have to be higher for longer in order to cool down demand.

Oil nears $100 per barrel

The soaring price of oil has provided additional support to this outlook.

Brent crude oil has risen 34% from a mid-June low to trade at above $96 per barrel on Thursday, its highest level since October last year. This is primarily due to extended production cuts by Saudi Arabia, Russia and other members of the OPEC+ oil producer alliance.

Last week, the US oil inventories fell to their lowest levels in nine years.

The Strategic Petroleum Reserve, America's emergency reserve, has also plummeted over the last two years. This is after huge amounts of oil have been released to protect consumers from the energy shock caused by Ukraine war. Goldman Sachs said that the shrinking reserve limits Washington's ability protect consumers from Saudi Arabia's aggressive cuts in supply.

Russia also ratchets up the pressure, restricting oil exports such as gasoline and diesel -- ostensibly in order to alleviate shortages at home.

Giovanni Staunovo is a strategist with UBS and he expects Brent oil to trade between $90-$100 per barrel in the next few months. It will end the year at $95 per barrel.

A sick China

Stocks have also been pressured by a flurry of disappointing Chinese economic data.

Youth unemployment is at record highs in the world's second largest economy, which is also mired in debt in its massive real estate sector.

According to the National Bureau of Statistics, consumer spending, production in factories, and investments in long-term assets such as machinery and property all decreased in July.

China's economy, despite a better performance in August and the lifting of zero-Covid in December, has been underwhelming this year. Investors have not seen the boom in demand they expected as a result.

Hong Kong's stock market suspended shares of Evergrande Group, its two subsidiaries and a reminder that China’s real estate crisis has not yet ended. This suspension stoked doubts about the company’s ability to restructure and avoid liquidation. Later, the company announced that its chairman is being investigated for alleged criminal acts.

The high debt levels in China's real estate sector has caused some financial institutions to be concerned about the stress they may face. They have extended loans to developers.