Last week saw the annual gathering of central bankers at the Jackson Hole Economic Symposium in Wyoming. During his highly anticipated eight-minute speech, Federal Reserve Bank Chair Jerome Powell slashed the fortunes of America's richest people by US$78 billion. The primary focus was the Fed’s outlook for monetary policy: it is set to turn significantly more hawkish than either the audience or the financial markets more widely were expecting.
The ensuing market rout saw the leading Wall Street indices retreat rapidly throughout Friday’s trading session. Falls of between 3% and 4% had been registered by close of play that day. In total, the speech wiped out US$2 trillion in global stock market capitalisation terms. In the bond markets, the benchmark US 10-year Treasury yield rose to 3.03%, while the US dollar strengthened even further against a basket of leading currencies. As for the S&P 500 Index, each and every one of its 11 sectors took a hit.
In his short speech, he sidestepped any talk of dovishness that he may have displayed in any of his other recent public appearances. It had been suggested in his previous updates that interest rates might not necessarily need to rise quite so aggressively as initially predicted. In other words… it might be possible to avoid a recession.
Instead, he promised to take “forceful and rapid steps” to moderate demand to better align it with supply and bring down inflation and prices, acknowledging that this would most likely cause “some pain” to households and businesses. It is now quite clear that we can forget about any pause in monetary tightening and that the path to lower inflation will be anything but straightforward.
Many economists and the financial markets more generally were expecting Powell to outline the need for higher rates. But investors were left stunned by the significantly harder tone that he adopted. After all, it was only just over a year ago that inflation was being described as “transitionary”. That word was ditched in December when focus shifted towards tighter monetary policy.
Neither central bankers nor government officials are immune from making mistakes. President George W Bush even hosted a meeting of finance ministers from a group of 20 countries at the White House in 2008 and apologised for the economic, financial and social damage being wreaked by the Global Financial Crisis, suggesting that the US was accepting full responsibility for it.
The global economy is clearly facing another crisis as a result of rising inflation in many countries. To tackle it, central banks have had little choice – other than to aggressively hike up interest rates.
The problem, however, is that they have let the inflation genie out of the bottle. With inflation now at a 40-year high, the challenge is now significantly harder: many commentators are suggesting that they made a major monetary policy error in taking so long to raise interest rates.
The Bank of England and the European Central Bank are now likely to adopt a more aggressive approach to monetary tightening. Unfortunately, economies the world over are burdened by rapidly rising inflation, creating a nasty backdrop of rising household costs coupled with higher levels of poverty.
Conflict in Europe and growing tensions in the South China Sea have triggered a rise in global defence spending. Japan’s Prime Minister Fumio Kishida, for example, believes that the international community has entered a new era of crisis. His party is on the verge of approving its biggest defence spending programme since the end of World War II.
In the UK, Ofgem now predicts that typical annual household gas and electricity bills will rise from £1971 to £3549. That’s an 80% increase. Industry consultants are even predicting that energy bills could top £6600 by spring 2023. That's more than five times higher than just one year ago.
Energy costs have spiralled since the Russian invasion of Ukraine, leaving European gas prices at their all-time highest levels. In response, the EU is to hold an emergency meeting of energy ministers in a bid to tame costs and stave off recession. Meanwhile, gas continues to be in short supply: Russia slashed exports to Europe on the key Nord Stream 1 pipeline in June and winter rationing is now a real concern.
In the UK, the Conservative party leadership contest is in its final stages, with energy policy the key focus in all discussion and debate. The threat of even higher inflation and an increasingly gloomy outlook for the UK economy and interest rates have seen the sterling tumble against other leading currencies.
The suggestion that UK inflation might even hit 18% next year (as US inflation starts to decelerate) is leading to speculation that the pound might reach parity with the US dollar at some point soon. UK exporters would, needless to say, benefit from such a weak pound. But importers would be hit by significantly higher costs (commodities, etc.).
At the moment, the job of Prime Minister seems more of a poisoned chalice than ever before. So much of the current economic turmoil has been created by forces beyond our control and over which the final two contenders have little influence. Can they really relish the prospect of tackling all that lies ahead?
Historically, British politicians have had a complicated relationship with the pound. Indeed, numerous prime ministers have found themselves in the position of having to shore up the sterling. Harold Wilson and John Major lost their premierships as the pound took a beating, and even Winston Churchill almost suffered the same fate.
Most of last week's market action came towards the end of the five-day trading period, catalysed by Jerome Powell's hawkish address to the Jackson Hole Symposium. Unsurprisingly, this triggered a sell-off in risk assets (equities). Almost inevitably, as we head into autumn against a backdrop of uncertainty over the direction that inflation will take, alongside rising interest rates and several rogue geopolitical factors, the equity markets are likely to remain volatile.
But as seasoned investors are well aware, uncertainty brings with it opportunity. And we are always on the lookout for openings – in line with our overall investment philosophy.