Stock market, why this inflation phobia? – 02/05/2022 at 08:11

Stock market, why this inflation phobia?  - 02/05/2022 at 08:11

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Jean-Paul Betbeze

Jean-Paul Betbeze

Stock markets are not unjust to worry, on the one hand from clear signs of bubbles (Tesla, Twitter) and on the other hand from the sting of future margins, which come from the rise of long interest rates.  (Photo Credits: Adobe Stock -)

Stock markets are not unjust to worry, on the one hand from clear signs of bubbles (Tesla, Twitter) and on the other hand from the sting of future margins, which come from the rise of long interest rates. (Photo Credits: Adobe Stock -)

Releasing its latest financial data for France on Friday, April 29, INSEE confirms a slowdown in growth and rising inflation. In a tense international context, Jean-Paul Betbeze explains why financial markets are hectic and have cause for concern.

8.5%: This is the rate of inflation in the United States. It panics the stock market and pushes Fed officials, led by President Jerome Powell, to take the lead in saying they will redouble their efforts to calm the blast. 7.4%: This is the rate of inflation in the eurozone, a rate that pushes Christine Lagarde to stop government bond-buying programs and talk about raising its short-term interest rates. But whether short-term interest rates rise or not, in the United States and the eurozone, inflation is working to raise long-term interest rates anyway. Here they are at 2.8% in the United States, 0.8% in Germany, 1.3% in France and 2.6% in Italy.

Reasons are added to explain this acceleration of inflation. The first is the exit from Covid, with a “spring effect”, after the fear of deflation in the worst case of the pandemic with, even today, the help left by the supportive fiscal and monetary policies. The second reason for this resurgence, so astonishing after these wonderful years of “moderate moderation” in prices, when growth has sustained, stems from the common effects of the Covid crisis and tensions with China. They undermine the liquidity of the old world production chains. These are the two production stops in China, for example in terms of electronic chips and bottled ports. The third reason is obviously related to the war in Ukraine, which raises the prices of raw materials and energy (gas & oil), but also food products (wheat) and fertilizers. These three reasons add up and penetrate each other.

The fear of cumulative inflation

In this context, the stock market is worried about inflation that would become cumulative. It would raise wages and escape the calming effect of rising short-term interest rates. Markets tell themselves that raising short-term interest rates does not bring more gas or wheat! Stock market concerns suggest that gains will be phased out and, worse, that growth expectations will be reversed in the United States.

The fear is that of short-term interest rates that go beyond long-term interest rates: the famous “reversal of the yield curve”. To measure it, it is necessary today to take into account the two-year interest rates: 2.6%, compared to the thirty-year-olds, at 2.9%, which are both market interest rates, “get rid” of the downward influence they have The Fed for short-term and ten-year interest rates as a result of years of quantitative easing. The slope of these two interest rates, 0.3% (2.9% – 2.6%) is so low that the US stock market is wondering about the risk of recession, caused by negative expectations.

Aggravating phenomenon in the euro area

In this context, inflation in the euro area is an aggravating phenomenon, as is the case in Canada, Australia and, even more so, in the United Kingdom. For the stock markets, this multifaceted inflation risks pushing central banks into a competition for interest rate hikes, while the economic recovery of course in the eurozone, even in the United States, did not solve the problems of the 2007-2008 recession.

In the eurozone in particular, rising long-term interest rates could pose a serious problem for Italy, which is heavily dependent on gas and Russian and Ukrainian food products. It is Italy’s risk of recurrence, as in 2012, that is pushing the ECB to limit short-term interest rate hikes as much as possible, at the cost of weakening the euro to 1.05 against the dollar.

Overall, current inflation worries the stock markets because it could be a harbinger of a recession in the US, and therefore at least a global slowdown. At the moment, difficulties are also emerging in emerging countries, which have to deal with rising long-term debt rates and the rising dollar, as well as food and energy inflation, which are likely to cause default. Already, in order to avoid rising social tensions in these countries, the IMF and the World Bank must set up debt restructuring programs. Will that be enough?

Stock markets are not unjust to worry, on the one hand from clear signs of bubbles (Tesla, Twitter) and on the other hand from the sting of future margins, which come from the rise of long interest rates. They can always tell themselves that the technological revolution is going on, but the clouds are still gathering, geopolitically and socially this time.

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