During the past week the primary Western central banks, the FED, the ECB and the SNB, put their cards on the table, openly declaring that they intend to raise their respective key rates well beyond what the international securities markets were already discounting, as evidenced by the decline in equity indices and the increase in bond yields since the beginning of the year. In practice, due to the marked inflationary upsurge caused by the war in Ukraine which caused the price of the most volatile components of the index’s reference basket to rise exponentially, the monetary authorities were taken aback, presenting an unacceptable gap between the current cost of money and the trending rate of inflation. Therefore, the only way forward is to amplify the incremental size of the base rate so as to induce an economic slowdown by this autumn, aimed at significantly reducing the cost of energy and raw materials, which for some economies will have recessive characteristics. To date, with the correction of the primary equity indices close to 20% from the beginning of the year, the stock exchanges have discounted the rate hike expected as early as the fourth quarter of 2021, aimed at normalizing monetary policy after the support measures needed to face the economic consequences of the pandemic. But with the recent decisions to tighten further, we enter a new bearish phase for the markets, discounting the inevitable recession induced by recent monetary policy decisions. Taking, for example, the USA S&P 500 index, which closed on technical support at 3750; medium-term bearish targets at 3250 and 3000 do not appear out of place. This would be a further decline of 15/20% from current levels, which in the past has characterized the market corrections that preceded an economic recession. A possible alternative could be a lateral distribution phase between 3700 and 4100 that characterizes the summer period, albeit, however, a prelude to the expected correction in the fall. This second hypothesis appears less likely, at least judging by the difficulties that the US indices have encountered since the end of April in realizing a technical rebound from oversold, but the Biden administration has every interest in not seeing a recession crystalize before the mid-term elections in early November, so the stock market could stagger before correcting further.
The generalized deterioration of the world economies induced by the increase in short-term interest rates is beginning to have a marked impact on currency dynamics; just think of the sharp depreciation of the yen against the dollar, quantifiable at around 25% from the end of 2021. Consequently, the Chinese central bank also had to intervene in support of its own currency which was dragged down by the Japanese Yen, given the important bilateral trade between the two countries; albeit not excluding a decision of an official devaluation of the yuan, whose defense appears incompatible with the problems relative to supporting the economic level that the Chinese economy needs given the concomitance of production shutdowns due to the pandemic and the endogenous and exogenous economic slowdown. In other currency news, the content of the speech by the Governor of the ECB, regarding the expected change of course in European monetary policy did not fail to surprise.
Meanwhile, to soften the consequences, the minutes of the Directory are surprisingly transparent, foreseeing a return of the Old Continent’s inflation rate close to 2% by 2024, precisely to avoid an excessive reaction from equity investors regarding the prospective swells of the base rate. But the less convincing aspect of what was declared in the press conference lies in the commitment to safeguard the spread on EU sovereign bonds of financially weaker countries from speculation, as this was possible in deflation and during the long phase of surreptitious liquidity creation that followed the Great Financial Crisis of 2009, but it is not possible during the current phase of credit tightening; paving the way for a weakening of the Euro against the dollar similar to that suffered by the Yen, which would bring the Euro exchange rate below par with the greenback.
Nicola Bravetti data source: Bloomberg
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