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Six months ago, I tried my hand at imagining how 2022 might transpire in markets, economies and politics. Whilst I am usually highly sceptical about forecasting (‘its role is to make astrology respectable’), my prognostics were sufficiently telling that I will now claim a certain wisdom.
The secret is to make ambiguous statements about a wide range of events, and some of them will stick. In this respect I prefigured Boris Johnson’s difficulties, the war in Ukraine (Bosnia was also a potential hotspot), Macron’s win and China closing down.
Looking ahead, it is stating the obvious that the shape of the next six months will be determined by the damage caused by the war in Ukraine and the policy response to high inflation though what is more interesting and challenging is to frame their secondary effects.
Perhaps the easiest factor to parse is the change in monetary policy from the Fed and other central banks, and the effect that this has had on technology and other growth stocks – at the depths of the sell-off in May, market stress indicators were recording levels only seen in major economic and financial crises (i.e. 2001, 2008, 2020).
In crude terms, the sharp change in monetary policy is a ‘policy mistake chasing a policy mistake’. Nakedly, overly-generous monetary and fiscal policy in 2020 and 2021 will now be corrected by a monetary policy overreach.
As such, my first ‘prediction’ to use that horrible term, for the rest of 2022 is that the market and economic dynamic will shift from financial market volatility to the contagious effects of this into credit markets. This is dangerous, and operating and financial leverage will rebound badly on companies exposed to them. For context, a worrying data release last week was that US credit card debt hit an all-time high.
In that respect I think credit spreads for risky companies and countries will rise and default rates will spike as we approach September. This may create enough stress on corporations and consumers that the rate hiking cycle comes to an end, though at a huge cost in terms of jobs and wealth.
Another tell tale sign is whether expectations of weaker demand bring the oil price down towards USD 75 per barrel, a shift that cosmetically would help to depress inflation. Energy prices, if we break down price indices, are the anchor of high inflation, and in this respect getting the oil price down is as much a test of America’s diplomatic power (over OPEC) as it is monetary policy.
This is just one factor that, as the ‘recession’ chorus grows in the media, will contribute to an increase in tension between politicians and monetary policymakers over inflation. In the USA the Federal Reserve has dampened the economic risks associated with the Trump presidency, whilst the aftereffect of this (high inflation) has dampened the approval ratings of President Biden.
As such, one offshoot is greater public tension between central bankers and politicians (who having blamed Putin for inflation will find other scapegoats), with a low probability event that Powell is not in his role by December, against a backdrop where with inflation and crime are the leading issues in the mid-term elections in the US. In Europe, Christine Lagarde and colleagues will find that markets test their credibility to the extreme.
This trend will map out across other countries, where climate damage and high food price inflation (and availability) will create political stress. Sri Lanka, Egypt, Ethiopia, and parts of Latin America are likely victims.
We have noted several times that it is noteworthy that governments that have experienced the political effects of inflation in the past (France with the gilet jaunes) have already done much to curb the impact of higher prices on their populations. Large country governments may try to become more involved in resolving supply chain blockages (German supermarkets have started rationing purchases) and countries like Venezuela might find that it is drawn back onto friendly terms with the US. Equally, another surprise may be that the US threatens to remove its security ‘umbrella’ from Saudi Arabia.
Perhaps the most long lasting effect of inflation is to undermine confidence in economic policy across the board, and to give the sense that ‘no-one is in charge’ and in turn this may undermine confidence in institutions (like central banks – the logical extension is that bitcoin should become a real store of value and not a Nasdaq tracker).
One important outlier in the inflation story, that in turn demonstrates how the military and financial worlds are interrelated, is the war in Ukraine. Whilst it has arrived at a tactical stalemate, the war still poses tail events – namely the prospect of a negotiated peace or of a Russian strike on Western troops in Poland for instance. Strategically, it is likely the end of the Putin regime as a credible power (to the extent that his use to China is to learn from his mistakes).
What will be interesting however is to see how much progress is made on the longer term strategic trends that have been unleashed by the war – notably the upgrading of Europe’s armies, the coherence of European foreign policy and how in particular it manages an emboldened Eastern coalition of the Baltic states, Czech Republic and Poland, and the speedy move towards renewables (and some dirty energy). We should also discover the true intentions of the US with respect to Russia – whether it supports a war of attrition to politically disarm Putin, or whether it opts to support a diplomatic solution.
Much of what I have said is quite gloomy, but that reflects the state of the world, in a context where globalization has come to an end (David Skilling of Landfall Strategy – we do strategic advisory work together for firms/governments/investors together – has another excellent note on this here).
A hopeful scenario is that by November many of the inflation/monetary policy imbalances are pared back (China’s economy is an important factor too) and that markets enter into a long period of calm. In turn this will bring to the fore many of the more exciting fields of innovation – medical technology, green tech and biomed for example. That would be something to look forward to but we have a choppy summer ahead first.