The US inflation shock is a harsh reality check for already shaken markets

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Given their debt levels – Italy’s debt-to-GDP ratio is expected to reach almost 150% by the end of this year and Greece’s closer to 190% – the prospect of a rapid rise European rates threatens further economic and political instability for already vulnerable countries. savings.

What happens in America is, of course, of great importance to Europeans and the rest of the world, because a more aggressive approach by the Fed – and it is inevitable that the latest inflation data will force a more aggressive – will have an impact on the rest. of the world via capital flows, US dollar borrowing costs and exchange rates.

Across Asia and the rest of the heavily indebted developing world, the combination of a strong dollar, rising interest rates, sky-high energy prices and the global economic slowdown threatens.

Even Japan, which does not yet have an inflation problem – its rate has been around 2.5% – is affected by the exchange rate, with the yen depreciating by around 15% against the US dollar. since the beginning of the year. While this traditionally helps Japanese exports, it’s starting to hurt because the cost of raw materials and energy that Japan imports (and pays for in US dollars) is skyrocketing.

Across Asia and the rest of the heavily indebted developing world, the combination of a strong dollar, rising interest rates, sky-high energy prices and the global economic slowdown threatens.

Rising rates in the United States pose a dilemma for central banks, like our Reserve Bank, because of their effect on monetary relativities and, if their currencies weaken significantly, the prospect of importing inflation through higher import prices. Fed decisions strongly influence global monetary conditions and policies.

The tech-heavy Nasdaq is down 28.5% year-to-date.Credit:PA

When Fed Chairman Jerome Powell releases the outcome of his Open Market Committee meeting that ends on Wednesday, he is likely to reveal the second 50 basis point hike this cycle and the third Fed rates this year. It will almost certainly signal another 50 basis point rate hike at the next meeting at the end of next month and further increases before the end of the year.

For markets that thought the worst might be over when April data appeared to show inflation peaking – stock and bond markets reacted positively to this data – the release of May figures was a harsh reality check.

The US market fell another 2.9% on Friday, with the Nasdaq index falling more than 3.5%.

The overall equity market is now down around 18.7% since the start of this year and the tech-heavy Nasdaq index is down 28.5%, as what had been – for nearly 14 years – the safety net provided by the Fed’s sensitivity to market volatility has been removed.

Bond yields, which had fallen after seemingly encouraging signs of a spike in inflation last month, jumped.

The yield on two-year U.S. Treasuries rose about 21 basis points to 3.06% this month and the yield on 10-year bonds rose more than 40 basis points to 3.16% . The Australian 10-year bond rate is now 3.67%. It started this year at 1.67%.

The rebound in the U.S. inflation rate came after what appeared to be encouraging signs that the worst supply chain issues that helped trigger the outbreaks were easing, with semi- drivers and the cost of shipping containers also down sharply. The consumer frenzy that was a feature of pandemic and post-pandemic environments also seemed to be losing momentum.

Russia’s invasion of Ukraine and its impact on energy and food prices and continued global supply disruptions due to China’s zero tolerance for COVID (just as it seemed as Shanghai and Beijing reopened after strict shutdowns, mass testing in these key economic hubs resumed over the weekend) created a high floor below global inflation levels.

The persistence of inflation rates at levels not seen since the dark days of the 1970s and early 1980s leaves central banks little choice but to go even further with rate hikes and the withdrawal continuation of the vast injections of liquidity from the unconventional policies that had remained in force. place, until very recently, since the financial crisis of 2008.

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The expansionary policies pursued by central banks in response to the financial crisis and, more recently, the pandemic have produced a series of unintended, or at least accidental, consequences, including bubbles in asset markets and interest rates rising from negligible to negative.

The next episode of major central bank monetary policies will bring about a similar transformation, even though the unintended consequences of the inflation-driven abrupt reversal of these policies are already, in their first phase, putting the world in a very different situation. and steering even less palatable.

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