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The Covid-inspired imbalance between demand and supply for goods was further aggravated by Russia’s invasion of Ukraine. Photo/PA
For investors and financial markets more broadly, an unknown enemy of rising inflation has swept the world over the past eighteen months, and central banks are now well on their way to trying
curb inflation while preventing an economic slowdown.
However, policymakers are clearly more concerned about the former, that inflation will not only feed into consumer and business expectations, but will also destabilize delicate political and geopolitical balances around the world.
Whenever governments panic and dramatically increase fiscal spending, inflation will tend to overwhelm the usual disinflationary pressures in an economy.
Over the past two years we have faced aggressive government fiscal intervention (spending on housing, climate change, transport and employment programs) as well as multiple black swan events, Covid and its variants to the continued occupation of Ukraine by Russia.
The response of global policymakers to the waves of Covid-19 has been to support demand at all costs. The biggest ramification of this support and surge in demand was the suppliers’ lack of ability to cope with this overwhelming force.
The combination of random shutdowns and the inability of suppliers to ramp up production to meet the sudden increase in demand for goods has led to shortages and bottlenecks along transportation chains.
As things stand, global demand for goods is now at least 10% above the long-term trajectory (much more in the US), while demand for services is now at least 10% lower. 5 to 15% to the trajectory.
The Covid-inspired imbalance between demand and supply of goods was further aggravated by Russia’s invasion of Ukraine and subsequent compression of the commodity space (from oil and gas to nickel and rare earth). Renewed lockdowns in China have also added to pressures in recent weeks.
From there, I think central bank policy error (and the accumulation of errors) is the biggest risk facing investors. Policymakers have relented and are embarking on major tightening cycles to reduce demand and moderate inflation.
However, societal indebtedness aside, we believe that many of the factors driving the headache are temporary in nature and therefore believe that global interest rate trajectories will need to be revised to support or stabilize demand again.
Three key factors will likely alter demand over the coming months:
1. An accelerated withdrawal of public spending. Global economies are on track to reduce fiscal deficits from around 11-12% of GDP in 2021 to around 6-7% in 2022, before further reducing them in 2023. This represents a shrinkage of around 3,000 billions of dollars in fiscal stimulus, and the fastest and deepest fiscal contraction since the end of World War II.
2. In economies currently undertaking interest rate hikes (US, Canada, Australia, New Zealand, Korea, Singapore and UK), current trajectories imply that around 2-3,000,000,000 USD of currency accommodation will be removed from demand during the period. next 18 months.
3. Unlike previous periods of tightening (e.g. 2015-18), this time the contraction in fiscal and monetary support is truly global and effectively coordinated, driven by the largest economy (i.e. say the United States).
Are we already seeing evidence of a slowdown? The answer is yes – political decisions from here will likely determine how far and how long this lasts.
– Mark Fowler is Head of Investments at Hobson Wealth. This article contains market commentary and factual information only and does not constitute financial advice.