The extremely delayed reaction of successive US Feds to inflation
The current difficult situation in world markets is primarily because successive US Feds have forgotten Monetary Policy 101—take the punchbowl away just as the party is getting started. This policy recognises that equity markets, when on a rising trend, accelerate when interest rates fall more than they should and investors are able to chase the then-current equity dream; it may work for a while, but, unless the Fed is vigilant, it always leads to rising—and, unfortunately, sometimes, galloping—inflation.
The denouement can sometimes be deferred for years, sometimes decades, because of forces that appear to be structural but are generally cyclical—the entry of China into the global markets keeping prices (and wages) low, productivity gains through technology, globalisation, etc. But the end, when it comes, always results in a major crash of equity prices and recession, after which the global economy takes a very long time to recover. This is why preventing runaway asset prices should be a fundamental part of monetary policy.
Currently, inflation is at a multi-year high of 9.1% and the Fed is, in most peoples’ view, still way behind the curve—the Fed funds rate is just 2.5%, so real rates are hugely negative. Many analysts believe that the Fed may not have to raise rates too much more since the recession (or near-recession) that is triggered, will bring inflation down rapidly. To my mind, this is just the kind of wishful thinking that can keep markets off-balance for a long time.
The second major force affecting markets today is the price of oil, which spiked above $130 a barrel on the Russian invasion, its highest in 15 years. While it has subsided somewhat, it remains volatile north of $100. This has been sustaining the inflation spike worldwide; more significantly, the price of natural gas that is the primary source of heating in Europe has more than doubled; further, Russia is threatening cutting gas supplies to Europe as winter approaches. This is beginning to destabilise politics there, as the fall of the Italian government shows.
The Russian invasion of Ukraine
Of course, the elephant in the room remains the continuing Russian invasion of Ukraine. This has not only created untold destruction, deprivation and sadness, it is clearly upending the existing globalised order (such of it that remains after the coronavirus pandemic highlighted the dangers of having extended supply chains). Many people in the Global South, while horrified by the trauma being inflicted on Ukraine, are finding it difficult to line up behind the West as this invasion brings back memories of Iraq, Syria and untold Western military misadventures. Countries like India, that have for decades depended on the Russians for military and political support, are trying to find a new global balance. Again, many countries are exploring alternative invoicing and payment processes, and while a genuinely multi-currency world is still a far cry, one of the key fallouts of the invasion is countries everywhere are recognising that they need to look out for themselves.
The war is certain bring about substantial change in global business relationships; Europe could see dramatic changes as growth slows; and while at first pass Putin’s invasion could drive Europeans to sleep even more closely together, continuing economic pressure could see the threat of the European experiment unravelling coming up again.
The push-me-pull-you nature of China’s recovery
China, which has suddenly become a staunch Russian ally (the enemy of your enemy is your friend), will doubtless be able to leverage Russia’s global weakness to its own advantage. However, its zero-Covid policy, and the upcoming Peoples’ Congress where president Xi Jinping is looking to consolidate his hold on power appear to be accelerating the slowdown in the country. It is hard to get a clear picture of what is really happening in China, but the shocking straight-line drop on copper, which is often seen as a surrogate indicator, may suggest that things are worse than they seem.
The strength of the dollar
And, of course, all these forces have come to focus in the strength of the dollar. The dollar index rose more than 13% since the start of the invasion, reaching its highest level in 20 years. It swept all before it, except for the Russian rouble and the price of oil; in particular, it pushed its heretofore competitor, the Euro, very close to ignominious parity.
Nothing moves in one direction forever, and over the past few days the dollar has suffered a small (2%) correction, with equity markets rejoicing by a strong 5%. Inflows into risk assets have stopped declining and the rupee, which looked flat on its back, has strengthened by nearly 1%. The big question is whether this is a real turnaround, or is it simply a bear market rally. There’s no way to know but to wait it out.
CEO, Mecklai Financial