Inflation’s point of no return is the real reason to worry
Every international fund manager is waiting now for the moment when the pendulum swings back to a more "normal" interest rate environment.
PATTRICK SMELLIE
OPINION: Among the many errors of judgment made by United States President Donald Trump has been to tweet about new record highs for the Dow Jones Industrial Index – the bellwether American stockmarket indicator.
Happily ignoring that US equities have been on a bull run for most of the past decade, President Trump is accustomed to taking credit for whatever the latest high point happens to be.
He has yet to claim responsibility for last Friday and Monday’s big corrections on Wall Street, felt on sharemarkets around the world.
Apparently never one to think ahead too far, Trump appears not to have realised there’s a reason most political leaders don’t boast about movements in financial markets. That is, it’s like taking credit for the weather. You know it’s going to rain one day and then whose fault will that be?
With a sharp recovery on Wall Street in late trading on Tuesday, the president’s Twitter-finger may well have been itching, but only the brave or the foolish would claim with certainty to know where things head next.
What we do know is that enough investors in US equities took fright at the same time, triggering the largest one-day fall in the Dow seen in the past six years and a spike in the VIX, or socalled ‘‘fear index’’.
With perhaps half of all stock trading now governed by algorithms that generate automatic buy and sell orders, any sharp change in market sentiment is exponentially magnified in the very short term by what computers rather than people think – a kind of automated lemming response.
The likely implications of such sharp swings can only be made sense of in a wider context.
Ironically, in this case, the dive in share prices is linked directly to how strongly both the US economy and the rest of the world are now performing.
In countries like the US, unemployment is so low that labour shortages should start comeback, and that will justify higher interest rates.
That, in turn, will encourage investors back into interestbearing products that have been unattractive for their low and, in some cases, negative returns in recent years.
The massive run-up in the value of global equities, real estate and other physical assets over the past decade has been in direct proportion to how low interest rates have gone.
Every international fund manager is waiting now for the moment when the pendulum swings back to a more ‘‘normal’’ interest rate environment.
Markets, being markets, tend to get to that point in a messy, unpredictable and sometimes volatile way.
The sharemarket rout and recovery of the past few days looks a lot like a lurch in the direction of a rational outcome in the event that global interest rates start rising. This is the rosy view and it assumes that inflation will, in fact, return. The fact that it hasn’t returned before now, however, is the great conundrum debated by central banks around the world.
Where has it gone? What if it doesn’t return? And what if there’s a wider unwinding of the massive government debts amassed over the last decade of the policy experiment in money-printing that stopped the global financial crisis turning into a deflationary global depression?
If that happens, central banks can’t repeat what they did for the past decade. That ammunition is regarded as all used up.
In other words, what should keep investors awake at night is not the prospect of a growthinduced correction to equity prices caused by an expectation of higher interest rates.
It is the prospect of another global economic contraction to which neither conventional nor unconventional policy responds.