Global financial markets run on “narratives”. The biggest narrative and the concern for asset markets from fixed income to crypto currencies is whether the central bank of the world’s reserve currency the U.S. Fed could make a policy mistake with regards to over hiking interest rates and inadvertently causing a global recession.
As stewards of capital and investment portfolios, the most important question fund managers face today is whether the 40-year trend of disinflation was ending in 2021?
There are another 5 fed meetings this year and the markets will vote on whether the FED committed a policy mistake. Mr. Market exhibits various psychological traits such as schizophrenia, manic-depressant and bi-polar behaviors as was displayed post the May 3-4 fed meeting and in its aftermath. The big political question in Washington is whether to support the dollar with higher US interest rates or whether the FED is taking stock market weakness into account when fighting inflation.
The current global stock market selloff is a unique and worrying because for the first time since former Fed Chair Alan Greenspan invented the so-called “Fed Put” during the 1987 stock market crash, the Fed Put is now kaput or out of order, having outlived its usefulness as inflation is even potentially complicating the role of the us dollar as world reserve currency.
Rampant monetary easing by global central banks to aid the global recovery from Covid-19 was spurring economic activity while debasing fiat currencies. The rising prices of gold and bitcoin are visible indications of this as investors sought to hedge their portfolios against inflation.
In a world where bonds are increasingly return free risk, Gold is the new zero-coupon bond, a safe-haven asset that doesn’t make interest payments at regular intervals.
The Fed has long been expected to step in to bail out markets whenever things got tricky., changing investor psychology and leading to complacency. But today it can no longer be counted on to do so. That’s because inflation hasn’t been as serious a problem as it is today since the Great Inflation of the 1970s. for domestic political reasons, U.S. president Biden increasingly blames president Putin for inflation, rather than the fed or his own democratic party, for causing higher geopolitical risk in the world.
Nominal interest rates are low in the United States and other advanced economies. Low nominal interest rates may constrain the ability of policymakers to provide accommodation through reductions in interest rates during an economic downturn. As the fed waited to too long when the stock market was in a bull market, to normalize interest rates it took covid and higher energy prices to put the fed into a bind.
Can the markets and the economy survive large monetary tightening? soft landing? this is the key question during war times when inflationary pressures take a toll on average people.
The unfortunate truth is that war and sanctions led to higher inflation.
Over the past year, inflation has been having a positive impact on analysts’ consensus forecasts for earnings in 2022 and 2023 but a negative impact on the valuation multiple that investors are willing to pay for those earnings estimates.
Needless to say, the former positive effect has been trumped by the latter negative effect. The negative impact reflects the jump in U.S bond yields so far, concerns that US dollar government bond yields will continue to move higher, and fears that this will all end with a recession.
The old market saying: when America sneezes, the world gets a cold. might as well apply again this year.
It is sometimes said that monetary policy is like shooting a moving target you can not see very well and hence is prone to policy mistakes.
In some countries like Canada, Interest rate trajectory will depend heavily on housing market. Rising interest rates are designed to slow the economy by making borrowing more expensive.
But this slowing might be amplified this time around because highly indebted households will face high debt-servicing costs and will likely reduce household spending more than they would have otherwise.”
The Interest cycle change will now be bigger and faster than in the past and this could cause recession.
US government debt increased by $1 trillion during the global financial crisis of 2008.
Just in the last 5 months, USA outstanding debt rose by $1.5 trillion. A reminder that we are not even in an official recession (yet).
The unfortunate development for more people around the world is that the inflation problem has shifted into a crisis for higher food prices and essential goods coupled with the real possibility that globalization is going into reverse, beyond the so called new cold war.
Due to the convergence of food, energy, debt and growth crises, a growing number of poorer countries face a rising threat of famine — and this is but one part of the “little fires everywhere” phenomenon undermining lives and livelihoods around the world.
Inflation at 40-year highs in wealthier countries is undermining standards of living and growth engines, hitting the poor particularly hard, fuelling political anger, eroding institutional credibility, and undermining the effectiveness of economic and financial policy.
Private- and public-sector efforts to strike a better balance between highly interconnected supply chains and national/corporate resilience are complicated by a global economy that lacks sufficient momentum for this to be done in an orderly fashion.
The western weaponization of international finance, while effective in causing market havoc has been pursued without a global framework of standards, guidelines and safeguards, further complicating the global inflation problem.
Inflation could be getting out of control as inflation expectations are rising and markets increasingly question western central banks.
The Powell Fed waited too long to tighten with its myopic mantra of "inflation is transitory" and has pivoted to monetary tightening at a time when economic growth and consumer spending has begun to decelerate. An ugly word from the 1970's now explains the macro zeitgeist: stagflation. Stagflation is potentially the worst environment for asset prices.
Global financial markets are turning into bear market territory as investors are increasingly not confident, the federal reserve will stop inflation. The sad market reality is that the only way to control inflation is by aggressive monetary tightening or with a recession in the economy.
Rainer Michael Preiss serves as an investment advisor & portfolio strategist.
