What impact will monetary policy divergence, geopolitical events and heightened volatility have on global financial markets? This was the question put to leading market commentators including Schroders’ chief economist Keith Wade, Invesco’s global macro strategist Arnab Das, and global head of economics and strategy for Allianz Global Investors Stefan Hofrichter, on Day Two of TradeTech FX.
Though the discussion was wide-ranging, the focus boiled down to two things: inflation and interest rates, with a deep-dive discussion on how to balance the opposing needs of monetary and fiscal policy. In essence – how can you stimulate the economy out of an oncoming recession, whilst still maintaining quantitative tightening to control runaway inflation?
“The only way to solve the problem at this point may be to have a recession.”
“The only way to solve the problem at this point may be to have a recession,” admitted Wade. “Monetary policy is beginning to work its way through, but it’s like a brick on a piece of elastic – you keep raising rates and raising rates and suddenly it bounces back and hits you. I think the Fed will keep raising rates for the time being, and I do think we may at some point still end up in a recession.”
Will we see a hard landing in the US? “I think the chances are getting higher,” said Das. However, he pointed out that despite the current pressures, the US is in fact under less pressure than other global markets due to a stronger dollar and other policy advantages. “The US is relatively straightforward,” he noted. “It’s no longer an energy shock or an issue of international prices, it’s a demand issue – inflation is coming through in domestic prices. Europe, on the other hand, faces a different set of challenges.”
Hofrichter elaborated. “The issues in Europe are not just about energy. It’s part of the story. But we also had very strong demand due to stimulus during Covid crisis. We have had some structural supply shocks, longer term, that are putting up prices. A tighter labour market on a global scale, the greening of our economy, all these are inflation factors.”
Different markets have responded to this in different ways, but the UK this week would appear to be a salutary example of what happens when things go wrong. With the currency crashing, a credit negative rating, and asset managers begging the Bank of England to step in to avoid a gilt crisis, it begs the question – what could have been done differently?
“The UK is a leading indicator for what could happen in other parts of the world: the pressure to provide fiscal stimulus is increasing to avoid recession. We hope it won’t come to that, but as winter continues the energy pressures will get worse,” said Das.
“There is a concern that monetary and fiscal policy are pulling in different directions, and the scale of that has produced this extraordinary volatility.”
“There is a concern that monetary and fiscal policy are pulling in different directions, and the scale of that has produced this extraordinary volatility,” explained Wade.
“We went through a tipping point yesterday with what was happening in the gilt market, the pressure on pension funds – it exposed a weakness that the Bank of England had to address. That was made worse on Sunday by [UK Chancellor Kwasi] Kwarteng saying he would continue to cut taxes – it showed no respect for what the markets were saying and the problems that it might create.
“It’s hard, when you’ve lost credibility, to get it back. And that’s a great pity when the UK has spent so much time rebuilding credibility after the financial crisis – an independent Bank of England, the Office for Budget Responsibility (OBR) – all thrown out the window in one go. I think Liz Truss might need to start thinking about who could be an alternative chancellor.”
Das added that what’s happening in the UK right now should be an “object lesson” for the EU. “There is potential for contradiction in the Eurozone as well,” he warned. “They might have to loosen the balance sheet to prevent fiscal instability, even as they tighten monetary policy to address the inflation problem. The answer perhaps is to target fiscal policy very tightly, rather than try to address it on a macro level, as the UK has done.”
Looking ahead, what is the likelihood that we might see rates come down at any point in the near future?
“For the time being, I don’t anticipate any easing,” said Hofrichter. “Given the current pressure, there’s much more need for central banks to hike rates. I think the market would be mispositioned to anticipate a pivot from the Fed or any major central bank any time soon.”
Wade had a slightly different perspective, believing that the process in the US is now on track to bring inflation down to 2%, which if achieved, could mean rates are eased slightly by the end of next year.
However, all panellists agreed that the US was ahead of the game on this, with other major central banks some way behind. “The Fed might look at cutting rates around 2024,” predicted Das. “But the UK and the Eurozone and, further behind, the Bank of Japan – everyone else is trailing the Fed by quite some distance.”
The Eurozone, suggested one speaker, has a little more time to work on it – inflation is spreading, but it can approach the issue in a “more considered way”.
“We think the ECB will keep rates pretty much as they are through 2023,” said Wade. “We’ve got them going to about 3%.”
The UK, on the other hand, is more entrenched, and rates are already higher, so it’s likely to take longer to bring those back down and things are likely to get worse before they get better. “The Bank of England will have to do something sharper, given the current turmoil and the crisis of recent weeks,” warned Das.
The session finished with a poll of the audience, asking traders their preferred (long) currency. Unsurprisingly, the US dollar took the lead with over 65% of the room, followed by the euro, and a small (and brave) proportion choosing pound sterling.