November 12, 2023 - 8:00am
Guys, this time I’m serious. That seems to be the message central bankers have started telling anyone who’ll listen, and especially the markets. The problem is, everyone seems to think they’re just saying that.
After US government bonds broke through the 5% level on their inexorable upward journey, they suddenly reversed course. A strong rally, apparently the result of short-covering, took them back into the 4% range. Thereafter a raft of soft economic data in Western economies, from weaker job creation to slowing inflation, along with some messaging from central banks that the heavy lifting in the fight against inflation was done, kept the rally going. By the middle of this week, with US interest rates heading back towards 4%, stock markets took the promise of cheap money and ran, recording their best week in a while.
The resulting loosening of financial conditions alarmed central banks, though. So on Thursday Jerome Powell stepped in to turn off the music and switch the lights back on. “The process of getting inflation sustainably down to 2% has a long way to go,” the Chairman of the Federal Reserve Board, the US equivalent of a central bank, told an IMF conference this week. His colleagues elsewhere were quick to concur, with Christine Lagarde saying that the European Central Bank wouldn’t be cutting rates for at least a couple of quarters and a deputy governor at the Bank of Canada adding that interest rates wouldn’t return to the ultra-low levels we once knew.
But investors have heard this all before. Ever since Alan Greenspan initiated the “Greenspan Put” after the 1987 stock market crash, investors have assumed that each time markets fall, central banks will put them back on track by cutting interest rates. Although central bankers have repeatedly tried to extricate themselves from this understanding, they have caved at each sign of stress in stock, bond or property markets. So investors have come to regard their protestations that this time will be different as little more than the boy crying wolf.
Yet things have changed since the end of the pandemic. Not only has inflation returned as a serious threat for the first time in decades, but contrary to what was initially assumed, it is likely to prove chronic (even if at manageable levels). Changes in labour markets and the global economy have altered the inflation regime, making it unlikely that inflation will return to previous levels very soon, if ever. That means higher interest rates are probably here to stay.
Moreover, despite cries from investors that the markets can’t bear much more pain, given how sharply central banks have choked off money supply, what they neglect to mention is the sheer volume of money still circulating. It’s true that over the last couple of years, central banks have sucked $6 trillion out of the global economy, an unprecedented tightening. But this is a small share of the more than $30 trillion they’ve pumped into the world economy since the 2008 financial crisis. With much of that money still around, markets can rally sharply every time there’s a hint that better days might soon come.
This battle of wills will likely continue. But with the exception of the Bank of Japan, which faces a peculiar problem in the country’s long stagnation, it seems unlikely the major central banks will back down this time — at least not until they are satisfied they have inflation firmly back under control. The Greenspan Put may never come back. When this finally dawns on investors, things could get rocky in markets. Investors should beware.
John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).
jarapley
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Subscribe“making it unlikely that inflation will return to previous levels very soon, if ever”
What’s the “if ever” doing here?
Inflation isn’t a force of nature. It’s a policy choice on the part of central banks. If they stop the money printing, or even slow it, inflation will disappear.
Yes, indeed. And if we still have a long way to go, why pause the interest rate hikes in the first place? It certainly gives mixed signals.
It’s unfortunate this article has dropped on a weekend when Unherd has three others with civilisational import attached to them. Attention has (rightly) been focussed elsewhere, but it’s no fault of the article.
Irrespective of the central banks we face a volatile decade with waves of inflation as part of the mix. In that sense it has characteristics of the 70s as many commentators have said. What is different from the 70s though is the debt:gdp levels which are leading us steadily into the weeds of financial repression until we aee dunked into the waters of yield curve control, capital controls, etc. We have a sovereign debt crisis (interest on govt.debt now creating a.doom loop.and – as Mosler says – creating inflationary effects!), ageing demographics, meaningful labour changes on back of gen. AI (was reading an excellent paper.on the impact of Chat on freelancers which is sobering), and a determination to limit access to energy at prices that can allow reshoring of key industries. A fascinating time to be alive ….
“fascinating time”! We may need to live through continued devaluation (inflation) for a long time given the debt situation nearly everywhere. Those being hurt the most rarely vote but we might expect illnesses of despair to increase among the least of us. The wage-price spiral has just started but not likely to cope well. What will be limited are investments to improve the economy and that looming recession will become reality.
The crash will happen in this coming week, when the consumer spending report for October is published and shows a marked slowdown in purchasing due to the reallocation of disposable income towards recently reactivated student loans.
I’m pushing back my prediction by two weeks, as it looks like the BEA’s consumer spending report won’t come out until November 30.
“Although central bankers have repeatedly tried to extricate themselves from this understanding, they have caved at each sign of stress in stock, bond or property markets.”
Yes, avoiding a complete meltdown is not easy when borrowing against borrowed assets, to pay interest on previous borrowing is rampant.