Equities have had a difficult New Year.  Interest rates are rising, growth is looking dicey and the pandemic's grip on the global economy and market psychology is unflinching. Central banks are headed in different directions. The Federal Reserve and the Anglosphere are tightening, the ECB, the continent, and Japan are neutral and China is loosening.  Join FXStreet senior analysts Yohay Elam, Eren Sengezer, and Joseph Trevisani for an examination of this most unsettled moment in the global economy.
 
Yohay Elam: The NASDAQ index has entered "correction territory" by falling over 10% from the peak. It is only one sign of the recent downbeat mood in markets. What is behind this fall?
 
Joseph Trevisani: Economic growth is slowing, prices and supply worries are rising, an invasion or incursion by Russia into Ukraine could tip the world into recession. Interest rates are rising and the Fed seems determined to address inflation. 
 
Eren Sengezer: PBoC's intention to loosen the monetary policy is also a warning sign
 
Joseph Trevisani: Exactly.  The Fed has been way behind the curve on inflation. If growth slows sharpl can they switch policy again. The Atlanta Fed has US GDP at 5.1% in Q4.
 
Yohay Elam: Indeed, I think that fears of aggressive action by the Fed – in response to high inflation – is the main reason for the sell-off in stocks, at least tech ones.
 
Joseph Trevisani: Initial claims were 286,000 in the January 14 week, the third rising week in a row.
 
Yohay Elam: That is the week in which the NFP surveys are held, perhaps an ominous sign.
 
Joseph Trevisani: I agree the Fed is probably the main reason but economic concerns are multiplying.US retail sales are another concern.
 
Yohay Elam: So, weak retail sales, worries about the labor market, and also the fading out of fiscal stimulus – perhaps the Fed could convey a more dovish message next week. That would help markets and also fuel critics saying the Fed works for Wall Street.
 
Joseph Trevisani: Yes it might help markets but it won’t help the economy. It might also spook the markets.  What does the Fed know?
 
Yohay Elam: Similar to what Eren said about the PBOC.
 
Joseph Trevisani: Yes.
 
Eren Sengezer: And there is a real risk of the Fed losing credibility if it suddenly changes its tone.
 
Joseph Trevisani: Very much.  The Fed has been Pollyanna on inflation for more than a decade and markets have discounted its predictions. Policy switches are a different order of concern.
 
Yohay Elam: The Fed announced tapering in November and then doubled the pace in December. Will it end bond-buying altogether in the upcoming meeting? It would be another hawkish tweak. The effect would be negligible, but the message would further spook markets. I think they'll leave the policy unchanged.
 
Joseph Trevisani: I agree, I don't think they will change.  We have come to the logical termination of Bernanke's transparency policy.  For transparency to be useful it assumes that the Fed is right in its economic analysis and that it knows what to do. Neither assumption holds.
 
Eren Sengezer: The Fed is really caught between a rock and a hard place this time around. A dovish shift could deliver the wrong message, another reduction in purchases could lift yields and further weigh on stock markets. Staying on hold seems to be the best option.
 
Yohay Elam: In general, central banks prefer sitting on their hands. So, no change in January, but will Chair Powell convey a clear message about hiking in March? He refrained from doing so, but several of his colleagues were more hawkish.
 
Eren Sengezer: I think the Fed wants to buy time in hopes of price pressures starting to ease before the March meeting.
 
Joseph Trevisani: Perhaps the global economy will take its cue from Johnson in the UK, who has lifted all mandates and presumably wants to revive growth.
 
Yohay Elam: While Johnson's moves are based on a drop in cases and also a desire to revive growth, political motives are also in play. I think China's pro-growth policies are more significant for the global economy.
 
Joseph Trevisani: Let me give a small example.  Canada and the US are essentially one economy. Trudeau has installed a strict regime of mandates for cross-border truckers. It began on January 15. No unvaccinated US drivers are allowed to cross into Canada. The US begins a similar policy on January 22. Many truckers are unvaccinated. I saw one figure at 40%, but it is particularly hard to assess the group. The impact on US and Canadian manufacturing, especially in automobiles, and in the springtime foodstuffs, is enormous.
 
Yohay Elam: China seems to be marginally easing its zero covid policy. It's called "dynamic clearing" now or perhaps they are trying to hide it ahead of the New Year, Olympics. For the global economy, the fact that Tianjin remains open is good news.
 
Joseph Trevisani: Zero Covid is a foolish and dangerous policy. The Chinese are pragmatic.
 
Yohay Elam: It worked for them when the virus was not that contagious, Omicron is a different kettle of fish as Boris Johnson and his fellow Brits say.

Eren Sengezer: China's Covid policy could prolong supply chain disruptions and that is a major concern.

Joseph Trevisani: Perhaps, though no figures from China are trustworthy in the least.

Yohay Elam: The only trustworthy figures from China are imports and exports, data that can be compared with other countries. And that's the critical data for inflation.

Joseph Trevisani: Yes.  It is possible the first quarter or first half sees a sharp drop in growth.  What happens if Russia invades Ukraine?  Oil prices spike. With the US removed as a swing producer, will Saudi or OPEC take up the deficit?  I doubt it. It is one thing when oil is rising from demand. It is quite another when it is an artificial supply question. WTI is at a seven-year high this morning.

Yohay Elam: Russia-Ukraine, I think it would turn into a buy-the-dip opportunity in markets. News of tanks crossing the border could scare markets, but I don't think Russia will go for an all-out war. Eren mentioned Dr. Strangelove to me earlier this week...

Joseph Trevisani: Great movie. Peter Sellers particularly and George C. Scott and Sterling Hayden.

Eren Sengezer: It's a great illustration of using game theory to solve international conflicts.

Joseph Trevisani: And Slim Pickens.

Eren Sengezer: Or failing to do so.

Yohay Elam: Yeah, that movie came out during the Cold War, when a US-Soviet clash would be Armageddon.

Joseph Trevisani: I think the global economy is more fragile than most realize. I remember the civil defense drills in school.

Yohay Elam: Why is the global economy fragile? End of pandemic-era fiscal stimulus?

Joseph Trevisani: Transformation.  We have all been puzzled by the unwillingness of workers to return to their jobs.

Yohay Elam: That's mostly a US phenomenon. Well, the US is the world's largest economy...

Joseph Trevisani: Reality is a hard school, so I think workers will eventually need to work, but I worry about the interim. And the US is the largest market by far.

Eren Sengezer: "Physical money" lost its meaning in my opinion with the digitalization of payment systems and transactions.

Joseph Trevisani: The digital transformation reaches deeper and deeper into economic, political, and individual life.  Instability is one result. For the markets, the Fed's misapprehension on inflation is one result.  They did not expect the prolonged labor or supply shortages.  They were perhaps also lulled by experience with quantitative easing in the prior decade which produced no inflation despite its massive flood of liquidity.  Times change.

Yohay Elam: Years of falling short on their inflation targets led them to change policy in 2020, prioritizing employment over inflation. The pendulum swung surprisingly fast toward inflation.

Eren Sengezer: People change too. The Fed has realized that they can't influence people's decisions using monetary policy.

Joseph Trevisani: Modesty is a rare commodity.  The Fed could use more.  Its tools are a blunderbuss, not a rifle. The US 10-year is 1.83%, the 2-year 1.04% this morning.  Credit markets have pulled back from a rapid ascent.

Yohay Elam: That may reflect fears of a global slowdown, but also perhaps a bit more Fed support.

Joseph Trevisani: That is still below the 2.25% approximate average of the prior decade. I think the rates are not a threat to the US economy, not at this level, but markets are a different story.

Yohay Elam: If yields hit 2% and remain stable, it would be a sign of normalization. A normal economy and normal Fed policy, but not so fun for markets.

Joseph Trevisani: Yes, I am sure that is what the Fed is hoping.

Yohay Elam: Froth-trimming 2%.

Joseph Trevisani: Equities will manage, economic growth will overtake rate worries.

Yohay Elam: Yeah, earnings still matter most. But perhaps investors will learn to accept "as expected" earnings as good news, not look for an overextended beat.

Joseph Trevisani: The euro is about mid-point in its range of the last seven years, the Dollar-yen is at the high end, the Canadian Dollar at the high side and the sterling highish. There is no uniform view of the US dollar, individual circumstances matter more than general US policy.

Yohay Elam: Is the non-uniform dollar trading is a sign of normality?

Joseph Trevisani: I think investors in all markets would be overjoyed to get back to economic considerations.  Will they? I hope so.

Yohay Elam: Investors yes, traders, not so much. Economic considerations are less exciting than speculation and drama. I stick to my view that the dollar has broad, albeit not uniform, room to rise in the first half of the year, due to uncertainty about the Fed. But later on, when tightening becomes a fact, the greenback could slip back down.

Eren Sengezer: I agree that current circumstances favor the dollar at least in the first quarter of the year. Inflation developments and the pace of the Fed's policy normalization should become more clear afterward.

Joseph Trevisani: I agree also, the Fed is certainly more likely to raise rates than the ECB or the BOJ, though not perhaps the BOE or the Bank of Canada. As Eren pointed out the PBoC is loosening rates. Are national differences accountable for the directionals?  Perhaps the Chinese are worried about the economic effects of their zero-Covid policy. That seems possible. 

Yohay Elam: China wants stability around the Chinese New Year and the Olympics. They also have the five-year Party Congress in October. Perhaps afterward they'll return to "shared prosperity" – aka their forgotten communist roots.

Joseph Trevisani: I have been rereading some of Jonathan Spence's books on Chinese history. It is interesting how political systems agree with and are determined by a country's cultural history. In context I think you are right, Beijing wants stability, economic stability knowing it will facilitate political control. 

Yohay Elam: They were chasing growth, but in 2021 they began talking about shared prosperity, chasing tech tycoons and property developers. Maybe now they are taking a pause in favor of stability, but I think they will go for more control by force rather than by growth.

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