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Between the war in Ukraine, runaway inflation and recession rumors, financial traders are put to the test. On both sides of the Atlantic, the monetary weapon prevails. Jean-Paul Betbeze explains why markets will resist higher interest rates
Will the financial markets collapse? No. Resist moving, rather. After the rises in the United States and the euro zone of 0.75% that have just occurred, respectively to 2.5 and 1.25%, the markets will seek, in this world full of risks, opportunities to exploit and securities to sell , being informed as much as possible by what the Fed and the ECB want to do, which are (still) their beacons. It is not a question of counteracting them, that would be ruinous, but of knowing how far they will go in raising short-term rates and in managing their Treasury bonds, and therefore in raising long-term rates. What will this new equilibrium of not too inflationary growth look like, at what rates and when will it be achieved?
Let’s start with the Federal Reserve. The financial markets, which are said to process information better, have work to do between the technological revolution that continues, China that is slowing down, and the war in Ukraine that is accelerating inflation everywhere. In this confusing world, let’s go to Jackson Hole on August 26, where Jay Powell, the chairman of the Fed, gives us a short and simple message: Fighting inflation is his primary mission. He is now taking precedence over his other mission, employment, since the labor market is already too tight, fueling rising wages and prices. Therefore, the Fed will continue with its hikes: do not expect from Powell this wait-and-see attitude of Arthur Burns, his distant predecessor, who forced Paul Volcker to raise rates to 20% in June 1981, pushing inflation from 13.5 % in 1981 to 3.2% in 1982, but with a recession in 1982-1983 and an unemployment rate of 11%.
Let it be said: Powell will raise his rates, say to 4 or 5%, knowing that growth will have to continue to fall. But with the current unemployment rate at 3.7%, that leaves him some wiggle room. It will suppose that the layoffs will calm the salaries in certain services, pushing the unemployed towards others, less in tension. He also knows that the Stock Market has integrated its rate of increases of 50 basis points per Fed meeting, to worry first, each time, about a rise of 75 points, and then swallow it. And yet here are two quarters where GDP has been falling since January, does Powell want to go towards a “mid-recession”? It won’t be Burns or Volcker.
Let’s go to the ECB. Still in Jackson Hole on August 27, Isabel Schnabel, a member of its Executive Board, speaks. And that she announces even worse news, greater rises in interest rates, therefore with a higher unemployment rate. She will say in particular that companies adjust employment less than before when interest rates rise, with their more complex structures and with more and more intangible assets on their balance sheets, making an investment less sensitive to its financing cost. So she expects big increases in interest rates, like this September 8th. The central bank’s credibility in its guidance on expected inflation (forward guidance) has been affected by its failure to notice the current rise in inflation. Will we return to the original ECB, the one born from BUBA, which would pay less attention to the Italian situation? Much less Draghi, much more Trichet?
Let’s move on to China, where the Central Bank says very little, but has just cut its rates by another 5 basis points to 3.65%, after GDP fell 2.6% quarter-on-quarter at the beginning of the year. , in relation to the politics of these anti-Covid lockdowns that are driving down the yuan, plus the real estate crisis. The fact is that China exports more goods and services than ever and Russia more oil than ever. China benefits from US and European budget support, Russia from its gas, its oil, its wheat and its de facto allies.
Therefore, interest rates will rise in the United States and in the euro zone, they will weigh on growth, especially in the euro zone and in Italy, the dollar will rise against the euro and the yuan. All without major market crashes, with an IMF on the prowl, assuming, of course, that there isn’t another Russian madness.
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