First and foremost, it’s about central bank money printing. The purpose of today’s ultra easy monetary policies was to support demand through the ravages of lockdown, but they have also put a further rocket under asset prices, compounding an investment environment already overwhelmingly driven by ever more desperate search for yield.
Globally, stock and bond prices have risen roughly in proportion to the amount of money created. This is not to argue that rising stock prices are entirely a monetary phenomenon; there is at least some logic in the madness.
Companies have widely used the pandemic to restructure, while there have been many enterprises for which the difficulties of the past two years have been a positive boon – tech, home entertainment, home delivery, the digital economy, and so on. The big losers have been in relatively less significant sectors such as hospitality and already fast declining physical retail.
All the same, you do not exactly need to be an investment genius to figure out that a stock market all puffed up by ultra-low interest rates is going to suffer badly once that support is removed. My guess is that central banks, already caught unawares by the speed and strength of the inflationary surge, are going to have to act much more robustly to tame the inflationary tiger than they think.
According to the US Federal Reserve’s latest “dot plot”, a majority of those on the Open Market Committee expect to raise interest rates at least three times in 2022. But that would still leave the Fed Funds rate at less than 1pc, against 0.1pc currently, and is more than factored in by markets. Anything significantly greater, however, would spell big trouble for stock prices.
If the degree of inflationary pressure determines the future course of interest rates – not necessarily the case, by the way, as central banks seem increasingly captured by fiscal dominance – it is the strength of the real economy that will determine the degree of inflation.
For now, things look pretty grim. Taking the UK by way of example, economic confidence has again collapsed amid the renewed surge in Covid infections. Recent data, moreover, shows a marked fall off in wage growth, which up until a few months ago was more than keeping pace with inflation.
The Resolution Foundation forecasts that wages will actually fall below consumer price inflation this year, compounding the damage done to disposable income by rising taxes and energy bills. Yet if I am right about Covid, then the current dip in demand will soon be behind us; staff shortages would again be the primary problem, putting renewed upward pressure on wages.
Much higher energy bills are already baked into the coming year, but the pressure is on major oil and gas producers to significantly raise levels of output. If they don’t, the current squeeze risks pushing the world economy into renewed recession, which would be much worse for them than simply accommodating current levels of demand, causing prices not just to ease, but to collapse.
In any case, on the real economy at least, if not stock markets, I’m of the glass half full way of thinking, rather than half empty. On that note, and if you’ve managed to get this far, a happy and prosperous New Year to all.
