Around the world, financial markets look increasingly distressed. In Britain government-bond yields have surged (see chart) and sterling has slumped, prompting the Treasury and Bank of England to issue statements attempting to soothe markets. In Japan the government has intervened in foreign-exchange markets to stem the fall in the yen for the first time since 1998. In China the central bank has increased reserve requirements for foreign-exchange trading, in a bid to restrain currency outflows. At the heart of the turmoil is the relentless rise of the American dollar and global interest rates. There is little relief on the horizon.
Each market has its own idiosyncrasies. Britain’s new government plans the country’s largest tax cuts in half a century. Japan is attempting to keep interest rates at rock-bottom levels, bucking the global trend. China’s government is struggling with the consequences of a “zero-covid” policy that has isolated it from the world.
But all face a shared set of challenges. Most of the world’s currencies have weakened markedly against the dollar. The dxy, an index of the dollar’s worth against a basket of rich-world currencies, has climbed 18% this year, reaching its highest in two decades. Persistent inflation in America and the simultaneous tightening of monetary policy are making markets febrile.
Just before the wild volatility of the past week, the Bank for International Settlements, a club of central banks, noted that financial conditions had turned, as central bankers’ commitments to interest-rate rises were priced in by markets and liquidity in the American government-bond market deteriorated. After a brief and modest uptick in August, global stocks have hit new lows for the year: the msci All Country World Index is down by 25% in 2022. Stress is clear elsewhere, too. American junk-bond yields have climbed back to almost 9%, more than double their level a year ago. Corporate bonds that are just inside investment-grade quality, with ratings of bbb, yield almost 6%, the highest for 13 years according to Bloomberg.
Volatility is expected by corporate treasurers, investors and finance ministries. Hedges are purchased and plans made accordingly. But conditions have now strayed far beyond expectations. Just a year ago, few forecasters predicted double-digit inflation in many parts of the world. When markets perform worse than anyone had previously expected, problems emerge and policymakers face a menu of bad options.
The Federal Reserve’s commitment to crushing inflation no matter the cost is clear. Speaking after the central bank announced its latest rate rise on September 21st, Jerome Powell, its chairman, said the chances of a soft landing for the American economy were diminishing, but that the Fed was nevertheless committed to bringing down inflation. Research published by Bank of America finds that from 1980 to 2020, when inflation rose above 5% in rich economies, it took an average of ten years to fall back to 2%.
Global growth expectations are receding quickly. In new forecasts published on September 26th, the oecd club of mostly rich countries expects global gdp to rise by just 3% this year, down from the 4.5% it projected in December. In 2023 it expects growth of just 2.2%. As a result, commodity prices are falling. Brent crude oil is back to around $85 per barrel, its lowest since mid-January. Copper prices on the London Metal Exchange fell to a two-month low on September 26th. A weak world economy may also lead companies to start downgrading their profit forecasts, following on from FedEx, a global shipping company, which has warned of “global volume softness”. Rising interest rates have been painful for share prices; lower earnings would be, too.
A slowdown may not even bring about a weaker dollar. As investors head for the relative safety of the global reserve currency, the greenback often rises during downturns. For countries and companies around the world that is an ominous prospect. ■
