A new era for central banks & financial markets

The following is an excerpt from our Global Financial Markets report that deals with the current inflation scare, omicron, fiscal divergence between Europe and the US and the headaches for central banks. In the GFM we provide forecasts of FX, interest rates, stocks, commodities and inflation hedges:

"...The financial markets mainly focus on the fact that we are entering a new era. Inflation has declined structurally since 1980, and there has even been a risk of deflation since 1998, but especially since 2008. In order to prevent/fight deflation, more and more money has been created and interest rates have been depressed to ever lower levels. This policy has boosted total debt-GDP ratios to ever higher levels, while also resulting in mounting upward pressure on almost all asset prices. This period has come to an end. The risk of deflation has shifted to a risk of inflation as a result of corona and far higher public deficits.

Central banks have always argued that inflation is less problematic than deflation, as excessively high inflation can always be curbed via rate hikes, thereby slowing down economic growth – even to the point where a recession is triggered, if necessary. This is true, but soaring debt levels have rendered the economy very vulnerable to higher interest rates and lower growth – let alone a recession. A new credit crunch would soon erupt in such a scenario, while governments and central banks barely have any resources left to counter this credit crunch – they did have the necessary resources back in 2008. This scenario would quickly start to resemble the situation in the 1930s.

Central banks will pull out all the stops to stave off such a scenario. This means that they will have to ensure persistent high growth (while governments will have to implement structural reforms). This will be accompanied by (excessively) high levels of wage increases and inflation. This is not ideal, but it is better than risking a credit crunch.

This also means that we are fairly optimistic about the future growth rate of most economies. This is basically positive for corporate profits. However, a shift from profits to higher wages and higher financing expenses will be increasingly evident. This is the result of rising interest rates. This scenario will probably grind to a halt at some point, but this point has not yet been reached..."?

To read the whole report, visit https://ecrresearch.com/research/?area=gi_gfm