Making sense of recent volatility in global financial markets
Rate hike, tighter policy? What to expect from The Fed presser
Year 2020. The world got its first taste of the covid-19 pandemic; one that would leave millions of deaths and massive economic stagnation in its wake. Borders were closed, movement was restricted, businesses shut down or failed, and millions lost their sources of livelihood. While vaccines were eventually developed, inequity in distribution became the norm, leaving huge swaths of the globe dangerously vulnerable.
Two years later, the world continues to feel the effect of the pandemic. The virus developed multiple variants, thus hampering complete eradication. More so, the global economy faces uncertainties as it navigates the pandemic and countries try to keep their heads above financial waters. This blog looks at where we came from, where we are, and where we are likely to be headed in light of recent volatility in the financial markets.
Year 2020: Armageddon
As the pandemic hit, governments around the world reacted quickly with a number of fiscal and monetary policy tools. Financial ministries/treasuries borrowed heavily to purchase key supplies, including masks, testing kits, and isolation centers. Then they bought food stuff and/or distributed cash allowances. Even Nigeria had its massive palliative programs which cost billions of naira.
When the vaccines were developed, governments ordered millions of doses for their citizens. At least some governments did. On their part, the Central Banks of countries deployed a number of tools to help complement the actions of governments. These included drastic cuts in interest rates (in order to keep the economy afloat) as well as asset purchases to help increase money supply (quantitative easing). All these interventions came on the backdrop of a near halt in cross-border economic activities.
Thus, while expenses increased, revenues withered. With millions of lives on the line, anything was justifiable. Somehow, it worked. At least in some countries. The stock markets in many countries saw massive positive returns. Technology and healthcare companies had a field day. The sick needed materials produced by healthcare companies. The healthy needed entertaining distractions and fast deliveries to their homes. Companies like Netflix and Amazon had the best moments of their lives. However, all wasn’t gloom.
2021: More Problems
Labor shortages, halts in manufacturing capacity and disruption in global trade led to a worsening supply chain problem. The dilemma of the computer industry, where chip shortages became persistent, received massive media coverage. But the computer industry wasn’t the only victim. Costly and unpredictable access to inputs affected numerous value chains, including the food & beverage, clothing and car industries. Even Christmas toys became too expensive for Santa.
Then there was the massive spike in energy prices, thanks to a coordinated supply cut by OPEC (the cartel of oil producing countries). The initial slump in oil prices that greeted 2020 was reversed in 2021 as prices hit multi-year high. But this also increased the cost of production for many industries, leading to further hike in prices of goods.
Inflation became a major problem for developing and developed economies alike. For a US Fed (central bank) that targeted a consistent 2% inflation rate, 6% became a reality. Still, the world needed to recover, so the high rates were deemed tolerable. Or so it seemed. On top of this, covid continued its onslaught, with the delta variant proving rather tricky for initial vaccine shots. This necessitated second and third boosters. More expenses for the government.
2022: The Reckoning
For nearly two years, the world priced survival above prudence. Politicians and their central banks justified expansionary policies on the need to keep people alive, and the economy above water. Now that there’s some semblance of stability, these policies are being questioned.
Investors are increasingly critical of central banks’ lax policies and the erosive impact of inflation on their earnings. Expectedly, central banks are having a rethink.
Talks of possible hike in interest rates have sent shivers across the stock markets, with the S&P 500 (an index of the biggest stocks in America) posting an 8.3% loss last week, the lowest since its record high in early January. Similarly, the Nasdaq composite index (a heavy concentration of technology stocks) faced a market correction, closing almost 10% below its November peak. Some of the biggest gainers in the past two years (such as Netflix) saw massive loss in prices in the past couple of days. Even the crypto market wasn’t immune from the cold bath.
Why is the interest rate so important? Well, the rate determines the cost of capital for companies. Increased rate means borrowed money will become more expensive, in addition to all of the challenges currently bedeviling companies around the world. More so, as interest rates on government bonds increase, some investors might choose the certainty of higher government bond payments over the volatility of the stock market, further increasing existing volatility. Add to this the persistent supply chain problem and relatively high energy prices and it's easy to see why the US Federal Reserve (and central banks around the world) might be in for a rough landing as it strikes a delicate balance between economic growth and price stability.
Where do we go from here?
That’s the billion-dollar question. The US Fed (and global central banks) has a mandate to ensure price stability. In a similar vein, it is mandated to ensure high employment and economic growth. Choosing between both is akin to choosing between the devil and the deep blue sea, seriously.
An aggressive interest rate hike would cool off inflationary pressures but risks slowing economic growth, even triggering a recession. A do-nothing policy on the other hand risks hurting the credibility of the Fed and causing massive damage to the purchasing power of consumers.
As the Fed Chairman addresses the world later today, we expect a middle ground policy involving a series of small but consistent rate hikes throughout the year, at least up to four times. However, these predictions hinge on a relatively stable recovery in the US and global economy.
Admittedly, a number of uncertainties remain. Supply chain disruptions, especially due to China’s continued zero-covid policy, remain. Furthermore, the world faces major geopolitical risks, including the Russia-Ukraine-Western standoff and the increased flare of the Yemen war as seen in missile attacks on major oil producers like Saudi Arabia and the UAE. A deterioration in either conflict would send energy prices over the roof, with significant consequences for the global economy.
Back home in Nigeria, any further external borrowings will be impacted by higher US interest rates while existing debt tied to variable indices like the LIBOR or US treasury rates would also become more expensive. This comes at a time when the country already spends nearly 74% of government revenues on debt servicing.
In conclusion, current volatilities in the financial markets shouldn’t be surprising. The world lived in a bubble of near-free money over the past two years at a time of war-like economic stagnation. We are witnessing a correction of the anomaly.