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Close Look: November 2022

2 months ago

Permacrisis: what’s the big story?

There is an old Chinese curse, which goes ‘May you live in interesting times’. As we come to the end of a chaotic year, with barely a dull moment, the full meaning of that curse has become clearer. Indeed, the word ‘permacrisis’ has been chosen as the word of 2022. It encapsulates the roller coaster of news and events that have defined the year. And often left financial markets reeling. We look at the build up to this state of chaos and lay the blame firmly on runaway inflation.

Following the Great Financial Crisis of 2008, central banks stepped in to rescue the world’s financial system. Interest rates were slashed and a new form of financial support was created, known as QE or quantitative easing. Interest rates were kept artificially low and, as liquidity washed around the system, the valuations of many asset classes soared higher and higher. Inflation was on its knees and central bank targets to pull inflation up to 2% seemed little short of fantasy. 

Then in 2020 came the Covid-19 pandemic, a game changer on many counts. As financial markets crumbled, interest rates hit rock bottom, even pushing below zero, and QE was relaunched. This unprecedented monetary stimulus was followed by fiscal or government stimulus, and in huge quantities. The rebound was impressive. Confidence was restored and consumer spending was boosted, but the seeds of inflation had been sown. And yet the US Federal Reserve (Fed) characterised the modestly higher levels of inflation as ‘transitory’ and delayed hiking interest rates. 

Eventually markets became uncertain as to whether the Fed was in fact getting ‘behind the curve’ on inflation and the jitters set in. Enter the period that has become known as The Great Volatility. Fast forward to the spring of 2022 and the Russian invasion of Ukraine. Energy and commodity prices, from wheat to metals, skyrocketed and inflation surged into double digits in many major economies. Rate hikes followed thick and fast, but still inflation raced ahead.

Sentiment, as ever, is key to market movements. And events which cause uncertainty over future outcomes will generally lead to bouts of negative sentiment and market volatility. But after a year of permacrisis, with equity bear markets a common feature and the worst year on record for US government bonds, financial markets are sensing better times ahead. As energy markets adjust to life without Russia and annualised inflation comparisons improve, the point where central banks pivot on the trajectory of their interest rates comes ever closer. Lower US interest rates should allow the dollar to weaken, further taking the pressure off global inflation. Although the possibility of ‘unknown unknowns’, should never be excluded, there are reasons to hope that somewhat less ‘interesting times’ might now lie ahead.

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