Financial markets are entering a dangerous new phase

aabout In the world, financial markets look increasingly deteriorating. Britain’s government bond yields rose (see chart) and sterling fell, prompting the Treasury and Bank of England to release statements in an attempt to calm markets. In Japan, the government intervened in foreign exchange markets to stem the yen’s decline for the first time since 1998. In China, the central bank increased reserve requirements for foreign exchange trading, in an effort to curb foreign currency inflows. At the heart of the turmoil is the continued rise of the US dollar and global interest rates. There is little comfort in sight.

Each market has its own characteristics. The new British government is planning the country’s biggest tax cuts in half a century. Japan is trying to keep interest rates at very low levels, contrary to the global trend. China’s government is struggling with the consequences of the “zero epidemic” policy that has isolated it from the world.

But everyone faces a common set of challenges. Most of the world’s currencies weakened significantly against the dollar. The dxyThe dollar’s value index against a basket of the rich world’s currencies has risen 18% this year, hitting a two-decade high. The persistent inflation in America and the simultaneous tightening of monetary policy are making the markets overheated.

Before last week’s extreme volatility, the Bank for International Settlements, a club of central banks, noted that financial conditions had shifted, as central bankers’ commitments to rate hikes were priced through markets and US government liquidity. Dam market deterioration. After a brief and modest rally in August, global stocks hit new lows for the year: Master’s The global all-country index fell 25% in 2022. The tension is evident elsewhere, too. US junk bond yields rose to nearly 9%, more than double their level a year ago. Corporate bonds that are only within investment grade quality, with ratings BBthe yield is nearly 6%, the highest in 13 years according to Bloomberg.

Fluctuations are expected from corporate treasurers, investors and finance ministries. Hedges are purchased and plans are made accordingly. But conditions now have deviated beyond expectations. Just a year ago, few forecasters predicted double-digit inflation in many parts of the world. When markets perform worse than anyone previously expected, problems arise and policy makers are faced with a list of poor choices.

The Fed’s commitment to crushing inflation no matter the cost is clear. Speaking after the central bank announced its latest rate hike on September 21, its chairman, Jerome Powell, said the chances of a soft landing for the US economy were dwindling, but the Fed was nonetheless committed to lowering inflation. Research published by Bank of America finds that from 1980 to 2020, when inflation rose to more than 5% in rich economies, it took an average of ten years to drop again to 2%.

Global growth prospects are receding rapidly. In the new forecast published on September 26, the Organization for Economic Cooperation and Development Rich countries club expects the world Gross domestic product It is only 3% this year, down from the 4.5% I forecast in December. In 2023 it expects growth of only 2.2%. As a result, commodity prices are declining. Brent crude is back around $85 a barrel, the lowest since mid-January. Copper prices on the London Metal Exchange fell to a two-month low on September 26. A weak global economy may also cause companies to start lowering their earnings forecasts, after FedEx, a global shipping company, warned of “softer global scale”. Higher interest rates have been painful for stock prices; Profits will be lower, too.

An economic slowdown may not even lead to a weaker dollar. As investors head toward the relative safety of the global reserve currency, the dollar often rises during recessions. For countries and companies around the world, this is an ominous prospect.

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