Some say in the snow.
what i wanted
I am with those who are in favor of fire.
But if it had to be destroyed twice,
I think I know enough about hate
To know how to destroy the ice
is also great and will suffice.
This short but exquisite poem by Robert Frost seems to capture the global economic moment we live in with poetic accuracy. On the one hand, markets are reeling under the fire of runaway inflation brought on by central banks, which have been exaggerated in response to the pandemic. On the other hand, markets are worried that the withdrawal of monetary stimulus, the ongoing lockdown in China and reduction in discretionary income will result in a slowdown.
First, a little history. The fire and ice debate in economics was fueled in the 1990s by a series of dueling columns by two of the great Morgan Stanley thinkers, Barton Biggs and Steve Roach. Roach said the West’s rising public deficit would fuel inflationary fires, while Biggs said the pace of (cheap) Asian labor and technological innovation would open a torrent of ice. As a young analyst who worked for the now deceased and missed Biggs dearly, I watched this duel from a ring-side seat. Biggs saw the debate as better at the time, but both gifted the economic world an enduring poetic framework. If it weren’t for the extraordinary response from the Ben Bernanke-led Federal Reserve, the 2008 global financial crisis could have easily led to an ice age. Markets often mis-calibrate, this was evident when the 2013 taper tantrum, triggered by the US Fed’s announcement of a reduction in bond purchases, resulted in carnage in the equity and currency markets of emerging countries.
The relationship between the equity and bond markets is an underlying phenomenon in the fire and ice framework. Due to its long history, I base the following comments on the US market. For nearly 40 years since 1960, the correlation of stocks and bonds remained positive; When the price of bonds declined, so did the stocks. For the past 20 years, this correlation has been mostly negative, providing investors with an inherent diversification option by holding both assets at the same time. In 2022, this correlation turns positive, with both stocks and bonds selling off at the same time.
Economic theory holds that equity and bond risk premiums rise (causing a fall in the markets) when inflation expectations rise. The joker in this pack is what the operative central bank does, in this case the US Fed. If the Fed tightens, thus anchoring long-term inflation expectations in a certain range, the stock/bond correlation will turn neutral or negative. Empirically, the range of inflation that the US market has been comfortable with is between 1.5% and 2.5%. Inflation below that level creates a fear of ice, and above that a fear of fire.
Therefore, markets today are not as concerned about runaway inflation or a deep freeze as uncertainty over whether the Fed can “fly off the plane” into the comfort zone with its hands on the monetary joystick. The range of fire and ice catches wide, even for the European Central Bank and the Bank of England. Although the actions of these central banks influence emerging markets, it is difficult to establish empirical categories for each of these markets given their short history.
A mini taper tantrum is already at play with the US dollar rising against most currencies and global capital returning to the safe-haven US coffers. The event is likely to accelerate when the Fed begins to reverse its balance sheet expansion this week, a process known as quantitative tightening. The Fed would achieve this by initially “not rolling over” more than $30 billion per month of securities held in its open market account, and then increasing it to $60 billion per month.
Due to the lockdown in China, there is a possibility of snowfall in the markets there. Policy makers recently announced 33 stimulus measures to prop up their economy. Chinese policies include tax relief, duty cuts, value-added tax credit waivers, deferment of Social Security premiums, deferred loan payments for small businesses, and general “go” measures to increase infrastructure spending. If China is to meet its announced 5.5% economic growth target this year, it may need to introduce a one-time cash transfer incentive. The measures taken together appear to be chronological in the context of other parts of the world battling inflation. Huh.
India is somewhere in between. It is import inflation through oil and food prices and through other supply chains that are international in character. Domestic monetary inflation has been modest as the government has not extended much of that lever to deal with the pandemic. Against the US dollar, the rupee has generally held its ground over the past year, and the Reserve Bank of India has enough dollar reserves (now just over $600 billion) to manage a systematic exchange rate development. Is.
I believe that concrete central bank action and structural technology-based productivity will bias the longer-term outlook toward “soft-landing”. Nevertheless, the markets are likely to remain volatile for the foreseeable future as they oscillate between fear of fire and ice. ,
PS: “Don’t sacrifice high returns for low volatility,” said Barton Biggs, praising the virtues of patience in the markets.
Narayana Ramachandran is the chairman of Include Labs. Read Narayan’s mint column at www.livemint.com/avisiblehand