Understanding the Pending Global Recession and how it Affects the Markets

The year is 2022 and the U.S Federal Reserve has raised interest rates 5 times by October. While this is not the most dramatic tightening of monetary policy the global financial markets have ever seen, it is the most impactful because it involves far more central banks.

Since the 1990s, the focus of developed economies around the world has been stability and disinflation. Now, however, the plan has changed globally and we see central banks taking a deflationary stance to fight the effect of the post-Covid fallout, and energy crisis due to the Russia-Ukraine war. When the U.S raises interest rates, it strengthens the Dollar and in response, other central banks either raise their interest rates too or face currency devaluation.

Financial analysts all over the world are asking the same question: can interest rates effectively fight inflation without destroying the rest of the economy? The Fed has made it clear that it will compromise economic growth for stability, to ensure that inflation does not become deeply rooted and widespread. However, the concern of most experts is that since inflation wasn’t caused by low-interest rates, fighting it by tightening interest rates will solve some problems but create other problems like disability in the housing markets and decimation of personal and household finances.

Widening Demand-Supply Gap

If the global supply of goods and services cannot be met due to disinflation in global economies, the gap between what’s needed and what’s available will only continue to widen. This will impact the commodities markets, as goods cannot freely flow across international borders.

Reduced Spending

Higher interest rates incentivize saving, and when inflationary pressures rise, investors stay out of the markets due to uncertainty. This reduces the volume of market participants and liquidity.

Furthermore, while bear markets encourage mass equity accumulation, the current economic squeeze means that money that would have gone to investing is now allocated to the cost of living by individual investors. This will cause even more bearishness in the markets as the active players to move to short positions.

Stock Markets

Historically, the stock market tops out before the start of recessions and bottoms out before their conclusion. As a matter of fact, the S&P 500 bottomed out roughly 4 months before the end of a recession and hit a high 7 months before the start of a recession in almost every case. The S&P 500 is a good benchmark of what to expect in terms of a recession.

If we enter a global recession, Investors can look toward stocks that have historically performed well in recessions such as consumer and healthcare stocks.

Fluctuating FX Rates

As a global currency, USD is used by other countries to pay for goods and services. Higher interest rates strengthen the USD against other currencies, which makes their central banks have to raise interest rates or suffer currency devaluation. This will cause high volatility in the Forex markets.

Marching Orders

Whenever there is a widespread decline in the markets such as there currently is, the consensus is for market participants to find safety in following the market trend. In this case, that would mean shorting the bear markets with a careful mix of technical and fundamental analyses.

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