Unless you're a central banker, don't panic. In that case, what are you doing reading this? Don't you know that inflation in the United States is currently at 7% and is likely to reach that level in the United Kingdom? Aren't you supposed to be raising interest rates as quickly as possible?
I was just a few days ago reading about the impossibility of a 0.5 percent interest rate increase in the United States (in a tweet that has mysteriously disappeared from my feed since). The next thing I know, the market is pricing in a 100 percent possibility of a 0.5 percent interest rate rise…
One minute, Reuters says that Federal Reserve policymaker “Bullard does not believe a half-point rate hike really helps us,'” and the next, he is “urging” one.
Why? Because inflation continues to rise faster than projected.
Isn't that an oxymoron? Isn't a continued surge actually just excessive inflation?
The behavior of those tasked with keeping inflation under control has been as erratic as the inflation statistics themselves. Even markets are perplexed by policymakers' inflationary policies.
Financial markets are (supposed to be) one step ahead of what is actually happening. They also prefer to price in the direction of change rather than the change itself – whether the news is good or negative is less important than whether it was better or worse than predicted.
On sometimes, this results in odd market behavior. It's only strange if you're a step behind the competition.
Do you remember when good news was considered terrible news and bad news was considered good news? Back then, the premise was that positive news would lead to tighter monetary policy, which would be terrible for financial markets. As a result, the better the news from the economy, the worse the markets performed…
Bad news provided policymakers with an excuse to keep interest rates at zero percent and quantitative easing (QE – the creation of money out of thin air to buy bonds) in place for a bit longer. This was beneficial to the financial markets. Markets rose as a result of the dismal economic statistics.
It appeared strange at first, but in a world of heavy-handed central bank interference, it made sense.
But things don't make as much sense these days.
Central banks have a monopoly because markets are far too indebted as a result of Covid and years of low interest rates, as well as promises of further low-interest rates in the future. Borrowing risk looked insignificant, therefore the globe leveraged up.
However, because of all of this debt, interest rates cannot be hiked significantly without causing another financial crisis.
Then followed inflation, which should have compelled central bankers to hike interest rates…
What a pickle (of their own creation) they've made!
Nobody understands how to interpret the inflation figures right now. Is inflation beneficial or detrimental to stocks? Are rising interest rates a good thing or a negative thing? Will higher interest rates cause a debt crisis or reign in inflation, or will they be too little, too late to contain inflation that is already out of control?
It's no longer entirely obvious. People can't agree on a story, even if it doesn't make as much sense as it did.
As a result, asset market price activity is out of control. In the United States, assets such as gold, bitcoin, the US currency, oil, and bonds dropped and skyrocketed all over the place as inflation news came out, and then again when central bankers' following statements were disclosed. Many prices traded past their starting position numerous times during the day, jolting up and down…
As a result, a single piece of news might potentially have several implications for markets. Nobody can agree on what it may signify.
A high inflation print might indicate that inflation is out of control, or it can indicate that central banks will be obliged to induce deflation by hiking rates too quickly — the polar opposite consequence from the same piece of data.
But here's what's actually going on behind all of this mayhem. The central banks are attempting to arrange what is known as a “soft landing,” in central-bank jargon. This is a legendary phenomenon that no economist has ever experienced, making it even more uncommon than a unicorn.
The core concept is that higher interest rates may slow down an economy without causing financial or economic havoc. That it is possible to reduce inflation without precipitating a recession.
When central banks do this, the result is…well, some type of financial or economic carnage and a recession.
The task for investors is straightforward. What will the financial markets price in next?
Will they factor in rising inflation? Or have interest rates been raised? Or the recession/crisis that higher interest rates would produce, bringing inflation back down?
Of course, we could get all of them in a row. Inflation might erupt, causing panicky interest rate rises and, ultimately, a crash.
So it all boils down to the age-old question: how far ahead does the market appear to be? Because the cycle is well-known and comprehended. It all happens again and again: boom, crash, inflation, and deflation. Despite this, the market is bouncing and jolting asset values all over the place, and then back again. It's attempting to determine which future event has the most impact on today's investment pricing.
Have you observed how central banks are plainly creating the business cycle rather than smoothing it? They're meant to tinker with interest rates in order to avoid busts and limit booms. However, they appear to be busy producing inflation and then triggering recessions in order to rein in their inflation.
And that is the fundamental issue here – one I make much too frequently, but you can blame central bankers and politicians for that.
Intervention in the economy has no positive effect. It aggravates them. Energy price limits induce energy price spikes. Low loan rates produce illusory booms, as we'll discuss in tomorrow's Fortune & Freedom video. Fiscal stimulus has a negative impact on economic growth. And the list goes on and on.
What we're seeing today is a moment of unprecedented government interference in the economy. Whether it's good or terrible at the time, the point is that it's going to be a major issue in the following months. Just like all government initiatives eventually show to be a problem.
All of this is what Paul was implying in his question to Nigel Farage. And you can see how Nigel responded in his most recent Question Time video, in which he answers a series of your questions.
By the way, we've had some great reader feedback on whether higher interest rates truly reduce inflation. Please email in your permission to reprint your ideas if you're reading this!
Before you go, one final thing. There is one sector of the economy that always manages to avoid the worst of government involvement simply because it is too innovative to tame. Regulators and politicians just cannot keep up with the rate of innovation in high technology.
And there is one major sector of the economy that is now miles ahead of governments, regulators, and central banks. That is why it is thriving. And why you should see this.
Editor, Fortune & Freedom
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