What had been unconventional became the norm in the major economies (US, Europe and Japan) because economic growth was, for most of the post-crisis period, anemic and inflation, ironically, almost non-existent. Key banks, and their peers elsewhere, doubled down when the pandemic hit.
Thus, since 2008, investors have had a rising floor and a safety net under the markets underwritten by central bankers.
However, global supply chain shortages that the Fed thought last year would be transitory (thanks to widespread lockdowns in China as it pursues its “zero COVID” strategy) continue and, with the impact on energy prices of the Russian invasion of Ukraine, contributes to the highest inflation rates in 40 years.
If, as investors seem to have concluded last Thursday, the Fed is determined to stifle inflation even at the cost of a recession, there is no relief in sight and no floor under a market that has been propped up since the financial crisis by a central government. without precedents. bank policies.
While there is some expectation that this week’s US April CPI figures will show a slight drop from the 8.5 percent recorded in March, an inflation rate that remains above 8 percent will not it gives the Federal Reserve room to fine-tune its monetary policies.
It will have to severely tighten financial conditions regardless of the consequences for the economy or investors. The last time he tried to raise rates and withdraw from his quantitative easing program, markets took a nosedive and he pulled back. However, inflation during that episode at the end of 2018 was only about two percent.
This time, the Fed won’t have to push interest rates to double-digit levels to kill inflation or the economy.
According to the International Monetary Fund, global debt levels have skyrocketed from 195% of global GDP in 2007, before the financial crisis, to 227% in 2019, before the pandemic. After central banks and governments responded to the pandemic, that share was around 256% at the end of 2021.
Governments, businesses, and households are now much more sensitive to small changes in interest rates than at any time in postwar history. The Federal Reserve will hope that a federal funds rate of at most 3 percent will be enough to control inflation, although some forecast that the rate will reach 5 percent next year.
Former Fed Chairman Paul Volcker, whom Powell said last week he admired, raised the fed funds rate to nearly 20 percent in the early 1980s to stamp out the runaway inflation of the time, which forced the unemployment rate into double digits. and the United States in recession.
Borrowers and investors globally will expect Powell to deliver his “soft” landing for the US economy (US interest rate settings and US financial markets are the dominant influence in global financial activity), but the more risk-averse will plan something else. brutal.
Monetary policies are crude instruments. Central banks have their policy rates, their balance sheets and their voices to try to respond to the myriad of influences, some well beyond their own jurisdictions, that determine inflation levels. Historically, they tend to overshoot their target in both directions.
In this interest rate cycle, it will not be surprising if the Fed and its peers respond too hesitantly or too harshly to the bout of inflation. Having lagged behind the curve, the risk to the US (and our Reserve Bank) is that they will be forced to take tougher stances than they might have if they had moved sooner.
It is debatable that a 40-year bond bull market is over. Nasdaq shares are technically in a bear market (down more than 20 percent from a high) and the broader stock market is headed in the same direction.
After almost a decade and a half during which central banks, and the Federal Reserve in particular, supported an unfounded rise in risky assets, the wheel is turning rather sharply. Risk and its price is, or at least should be, once again, an input in investment decisions. Bull market phenomena, like the chatroom-inspired crashes of retail investors we saw on GameStop and other episodes, should be a historical curiosity.
Unless the Fed chickens out, which it could if financial markets really start to unravel, the monetary policy setup that has buoyed financial markets since 2008 will largely fade. Better late than never, as many critics of unconventional central bank policies in the aftermath of the financial crisis would say.
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