Interest rate reductions show central banks are ready to plunge economies into recession to stop price rises of basic commodities.
The battle against inflation escalated this week as central banks increased their efforts to cool surging prices, and a global recession could be the best way to make amends.
Investors stumbled from the largest hike in interest rates in almost thirty years, before Switzerland introduced a shocking increase in its borrowing costs, concluded by the fifth consecutive hike from the Bank of England.
This series of rate hikes indicated that central bankers are very worried about the threat of severe inflation, and are ready to slow down the economy into a slump to cool it. The aggressiveness sent global stock markets reeling to their lowest point in over 18 months, in the largest weekly fall since March 2021 as markets entered “extreme bearish” territory.
America’s benchmark S&P 500 index tumbled into a bear market, down 20% from its peak, emphasizing that markets are in a steep, continuous downturn that could prompt a recession. Mark Haefele, the chief investment officer at UBS Global Wealth Management, stated:
“The more aggressive line by central banks adds to headwinds for both economic growth and equities. The risks of a recession are rising, while achieving a soft landing for the US economy appears increasingly challenging.”
Bond and currency markets were also shocked this week, while oil and copper prices were affected by slowdown fears. America’s central bank significantly toughened its resolve with a 75-basis-point hike on Wednesday, after an abrupt spike in consumer prices which implied that inflation had still not peaked.
Jerome Powell, Federal Reserve chairman, opposed trying to trigger a recession, but said demand had to be diminished to cool wage increases. Inflation is “very painful for people” and many are only encountering it severely for the first time, he told reporters.
Richard Hodges, manager of the $3.6bn (£2.9bn) Nomura Global Dynamic bond fund, said the Fed was planning a recession as it focused only on lowering US inflation from its four-decade high of 8.6% in May.
The Fed intends to reallocate the differential between post-pandemic, repressed demand and Russia-Ukraine, Covid-restricted supply by dampening demand, said Hodges, who forecasted that higher lending costs would affect the US economy fast. He added:
“In the latter part of this year, the economy will slow as the US consumer becomes increasingly squeezed by higher prices, a weak housing market, and, to an extent, reduced employment certainty.”
Switzerland’s central bank, the Swiss National Bank (SNB), surprised global markets on Thursday with its first interest rate rise since 2007. The measure caused a surge in the Swiss franc, and volatility through the foreign exchange markets, with the SNB saying it would hike further if necessary.
Jeffrey Halley, a senior market analyst at the financial trading firm Oanda, stated:
“It was probably the SNB that broke the camel’s back, because if the Swiss are worried about inflation, we all should be.”
In comparison to the drama in Zurich and Washington DC, the Bank of England’s quarter-point rate hike on Thursday appeared rather tame. But Threadneedle Street also vowed to act “forcefully” if necessary, causing many economists to forecast borrowers could be hit with a half-point hike in August. That would be the largest increase in UK interest rates since 1995.
Recession fears plunged the pound to a two-year low last week, leaving sterling with a drop of about 10% against the US dollar so far this year. Only the Bank of Japan defied the trend. It maintained its ultra-accommodative approach on Friday morning – and saw the yen quickly fall 2% towards this week’s 24-year low against the US dollar.
Global recession is coming. The boom in manufacturing sentiment indicators in the US has now fully reversed & we're about to go into recession territory. So we're now tracking a manufacturing recession on top of the US housing recession that's already been playing out… pic.twitter.com/wHbiZhP4Qc
— Robin Brooks (@RobinBrooksIIF) June 17, 2022
A global recession is already looming, cautioned Robin Brooks, chief economist at the Institute of International Finance. He said the US faces a slowdown in housing and manufacturing.
“Global recession is coming. The boom in manufacturing sentiment indicators in the US has now fully reversed & we’re about to go into recession territory. So we’re now tracking a manufacturing recession on top of the US housing recession that’s already been playing out.”
Despite the fall in equities this year, shares may still not be of good value. BlackRock said it was forgoing calls to “buy the dip” as valuations had not really increased, there was a risk of the Fed over toughening, and profit margin pressures were growing.
Mihir Kapadia, the CEO of Sun Global Investments, said:
“Stocks are looking quite cheap on measures such as price-earnings multiples on a historic basis, but the worry now is that a recession is imminent and earnings which are the denominator in P/E ratios may decline quite sharply.”
Memories of the Eurozone crisis came back last week, as the gap between safe-haven German and Italian government debt reached its strongest level since 2014. Fears that extremely indebted Italy was going back to the “danger zone” made the European Central Bank (ECB) organize an emergency meeting to acquire ways to cool the bond market rout.
Luis de Guindo, the ECB vice-president, said a new anti-crisis tool would control “unwarranted fragmentation” in the lending costs of eurozone members.
Nevertheless, the ECB could grapple to bring bond spreads under control while also tightening monetary policy. It could also trigger the ire of Germany if it offered government financing to some eurozone countries without conditions.
Mark Dowding, the CIO of BlueBay Asset Management, predicted:
“A greater sense of crisis will be required before policymakers act to address weaknesses within the fabric of the monetary union.”
Dowding said confidence in central banks would be required before markets could become steady, as well as data indicating that inflation concerns have been tackled. He compared the recent rate hike cycle to a trip to the dentist. He stated:
“From that point of view, it may be preferable to take the pain quickly and get the hiking cycle done, rather than drawing it out. In this way, the peak may end up being lower than otherwise may be the case.”
Cryptocurrency investors were clearly left feeling indifferent, after Bitcoin fell by 30% in a week, the cryptocurrency hedge fund Three Arrows Capital was unable to meet margin calls from its lenders, and crypto lending platform Celsius Network stopped withdrawals.
Having profited during the days of easy money, crypto-assets may not have reached rock bottom yet. Dr. Lil Read, a senior thematic analyst at GlobalData, concluded:
“We’re plummeting into a cold crypto winter, and we haven’t hit the freezing point yet. Rumors and fears are swirling that bitcoin will drop below $20,000 amid wider volatility in financial markets and sell-offs in other asset classes.”