{"id":183402,"date":"2022-12-22T17:15:00","date_gmt":"2022-12-22T22:15:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/traders-insight\/international-roundup-inflation-recession-stagflation-drive-market-selloff\/"},"modified":"2023-02-09T15:52:44","modified_gmt":"2023-02-09T20:52:44","slug":"international-roundup-inflation-recession-stagflation-drive-market-selloff","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/international-roundup-inflation-recession-stagflation-drive-market-selloff\/","title":{"rendered":"International Roundup: Inflation, Recession, Stagflation Drive Market Selloff"},"content":{"rendered":"\n

Economic growth across nations continues to slow and fears of recession are escalating in response to central banks cautioning that higher-than-expected interest rates and prolonged periods of monetary tightening may be required to battle decades-high inflation. On a positive note, various central banks have scaled back their aggressive paces of rate hikes while consumer sentiment levels in the U.S. and the U.K. have rebounded although they\u2019re still near basement levels.<\/p>\n\n\n\n

The modest improvement in consumer sentiment is being overshadowed by stagflation, or the toxic combination of slowing growth and persistent inflation, with the S&P 500 down roughly 2% in early trading. Yields for short-duration debt are up significantly but long-duration debt yields have climbed only modestly. The dollar is also climbing while crude oil prices have resumed their march upward as Europe enters the two coldest months of the year.<\/p>\n\n\n\n

In a move similar to the Federal Reserve (the Fed), the European Central Bank (ECB) last week increased its bank deposit rate 50 basis points (bps), which like U.S. policymakers, had previously hiked rates 75 bps. With the hike bringing the ECB rate to 2%, bank President Christine Lagarde emphasized that while the organization is reducing the size of its rate hikes, it has increased its forecasts of inflation 30 bps to 8.4% this year and 80 bps to 6.3% for next year. While price gains eased slightly from 10.6% in October to 10.0% in November, Lagarde said stronger-than-expected wage growth and a boost in demand created by fiscal stimulus in euro zone countries required the bank to increase its inflation forecast. The ECB also announced plans to reduce its multitrillion dollar balance sheet by approximately $16 billion a month starting in March.<\/p>\n\n\n\n

Lagarde\u2019s comments were similar to recent statements from U.S. Fed Chairman Jerome Powell on December 14. Powell and the central bank\u2019s Summary of Economic Projections implied that U.S. policy makers will boost the fed funds rate further and maintain the elevated rate throughout next year. The news triggered an equity market decline and bond yields climbed as investors who were anticipating a rate cut in 2023 reassessed expectations.<\/p>\n\n\n\n

The market and the Fed continue to disagree on the path of monetary policy in 2023, with investors continuing to price in interest rate cuts in 2023, challenging the Fed\u2019s resolve in battling inflation. The market seems to think that as the unemployment rate rises in 2023, the Fed will succumb to political pressure by incrementally neglecting its mandate to achieve price stability in favor of its mandate to maintain low unemployment. Chair Powell did pivot early in 2019 after committing to staying tight in 2018, which caused a stock market selloff and ratcheted up political pressure favoring lower rates. This time is different: inflation wasn\u2019t a problem then but is now, making an accommodative pivot a lot less likely but not impossible. In addition, Chair Powell has also stated that price stability is our \u201cbedrock,\u201d implying that price stability is more significant than maximum employment. He\u2019s stated that without price stability we won\u2019t have strong labor markets and a robust economy.<\/p>\n\n\n\n

While the European business environment remains challenging, the December flash PMI data released last Friday shows costs rose at the slowest rate for over one-and-a-half years, a result of supply chain improvements and weakened demand. For December, the overall Flash Eurozone PMI Index increased from 47.8 in November to 48.8 but remained below the expansion-contraction threshold level of 50. Overall business sentiment reflects the high cost of living, rising interest rates, persistent wage pressures, energy supply threats and the Ukraine war. Businesses reported only modest hiring increases.<\/p>\n\n\n\n

Like the Fed and ECB, various other central banks have scaled back their rate hikes. With the U.K. experiencing 10.7% inflation, the Bank of England last week raised its key interest rate from 3% to 3.5% and Norway, with 5.7% inflation, hiked its rate from 2.50% to 2.75%, the highest rates for both jurisdictions in over a decade. Norway\u2019s economy is expected to grow 3.6% this year and decline 0.1% in 2023, compared to a previous estimate of a 0.3% decline for 2023. The U.K.\u2019s economy is believed to be in a recession that started in the third quarter of this year and is forecast to last approximately one year, according to the country\u2019s Office of Budget Responsibility. The peak-to-trough GDP decline is expected to be 2%.<\/p>\n\n\n\n

The Bank of Japan (BOJ), meanwhile, surprised investors earlier this week by deciding to allow the country\u2019s 10-year bond yield to climb as high as 50 bps. Rather than describe the change as monetary tightening, it said the policy seeks to improve the country\u2019s deteriorating bond market. Prior to announcing the decision, the BOJ was the only developed-country central bank that had not increased rates. Like most countries, Japan\u2019s economy is struggling with inflation and a recent Reuters survey determined that analysts anticipate Japan will announce revised third quarter GDP of -1.1% on an annualized basis. Japan is also viewed as being vulnerable to weakening exports as other countries\u2019 economies slow against the backdrop of consumers favoring services rather than goods as the COVID-19 pandemic winds down.  <\/p>\n\n\n\n

Despite higher prices and tighter financial conditions, consumer sentiment is improving in certain countries, perhaps due to energy costs stabilizing or in the case of the U.S., declining significantly.<\/p>\n\n\n\n