London (Project Syndicate)- Do you believe in fairy tales? If so, you can probably make good money as a financial trader nowadays or gain power and prestige as a central banker.
While annual inflation in the United States, the eurozone and the United Kingdom has reached 40-year highs and will likely drop into double digits after the summer, financial markets and central banks. look confident That the war against rising prices would end by Christmas and interest rates would begin to fall by next spring.
Everything is right
If this happens, the world economy will soon return to the financially correct conditions of the Goldilocks fairy tale that has attracted investors for the past decade: neither too hot nor too cold, and always for profits. Correct.
, The question is whether the new era now beginning will, for the first time in a generation, be dominated by consistently rapid price increases; Or, for the first time in history, we would painlessly overcome an inflationary crisis with negative real interest rates and without the collateral damage of a major recession.,
Investor optimism can be seen in the recent trillions of dollars bets on three closely related market bets. money markets are now forecast that US interest rates FF00,
Will peak below 3.5% in January 2023 and then drop to around 2.5% next April to early 2024. bond market TMUBMUSD10Y,
prices are US inflation fell from 9.1% today to just 2.8% in December 2023. and equity market SPX,
Assume that the economic slowdown causing this unprecedented deflation will be mild enough for US corporate profits 9% growth in 2023 From this year’s record level.
Central bankers are more nervous than investors, but they are convinced of their economic models, which are still based on updated versions of the “rational expectations hypothesis” that failed so miserably in the 2008 global financial crisis. These models assume that Expectations Low inflation is the key to maintaining price stability. Central bankers therefore view inflation expectations as “well-stagnant”: evidence that their policies are working.
When central bankers and markets follow each other, both are likely to go astray. But this only partially explains the willingness to bet against the financial markets. Warning A return to the 1970s-style stalemate by noted commentators such as Larry Summers, Mohamed El-Arian, Jim O’Neill, and Nouriel Roubini.
buy at sound of cannons
I’ve just spent three months traveling around the world to discuss with hundreds of professional investors why, after a decade of Panglossian optimism about the prospects of the financial markets, I too have shifted to a markedly bearish outlook. I have gone These discussions have convinced me that today’s investor confidence rests on four misconceptions, or at least cognitive biases.
The first cognitive bias is to degrade and disregard geopolitics – a view articulated by Nathan Rothschild mythological instructions In the Napoleonic Wars “to buy at the sound of the guns.” Professional investors take pride in trading against fearful retail investors who sell their assets because of wars.
With one obvious exception, this paradoxical view has often been proven correct. Permanent war between Israel and a coalition of Arab states led by Egypt and Syria in October 1973 transformed The world economy in a way that ruined a generation of overconfident investors. He downplayed events that are reminiscent of today: an energy shock, rising inflation after a long period of monetary and fiscal expansion, and panic among policymakers, who simultaneously faced high inflation and rising unemployment. .
Squeezing Russia, one of the world’s largest producers of CL00 energy,
and many other commodities, have triggered a supply shock out of global markets at least as severe as 1973-74. Arab oil embargo And will go on for years. So restoring price stability will now require a long-term demand constraint that is hard enough to match the reduction in commodity supply. This means that US interest rates have risen by 5%, 6%, or 7% instead of the 3.4% peak that investors and central banks now assume. Nevertheless, the Pavlovian reflex of investors is to ease this geopolitical turmoil and focus on small adjustments to US monetary policy.
trend is your friend
This stance reflects a second cognitive bias, which is summarized in the investing adage “trend is your friend”, which means that Change Market-moving economic indicators such as inflation, unemployment, or interest rates are more important than them levels,
Many investors accordingly believe that monetary conditions have become too tight as central banks have raised interest rates in increments of 0.75 percentage points instead of the usual 0.25 percentage points, despite the fact that rates are still higher than in any previous tightening cycle. I have very few.
Similarly, investors appear unaffected by inflation above 9% as they expect it to drop to “only” 7% by December. But businesses and workers in the real economy will still see prices rise at their fastest rate in decades, which is bound to drive corporate pricing strategies and pay off negotiations for 2023.
Fed. don’t fight
Such a conclusion seems obvious—except for financial traders subject to a third cognitive bias: “Don’t fight the Fed.” This preferred market says that once the US central bank becomes serious about achieving an objective, such as an inflation target, investors should always assume that it will get its way.
This makes sense when the Fed is actually willing to do whatever it takes to meet its goals, for example regardless of the impact on unemployment, the stock market and debt-servicing costs, regardless of the obvious manifestation of low inflation. by following through. But today’s Fed is so focused on “well-stagnant” inflation expectations that it’s fairly relaxed about “backward-looking” data showing prices rising much faster than most businesses and workers expect. Used to be.
Nothing new under the sun
This leads to a final bias: Most people find it difficult to imagine events that have never happened in their lifetime. For many investors and policy makers, stubbornly high inflation falls into this category. Market knowledge expresses this bias Proverb That “there is no new era.”
But new eras happen, as the world painfully learned in 1973. And the interaction of Russia and COVID-19, along with today’s economic and fiscal expansion, has created unprecedented conditions that guarantee that the period ahead will be very different from the past 40 years.
The question is whether the new era now beginning will, for the first time in a generation, be dominated by consistently rapid price increases; Or, for the first time in history, we would painlessly overcome an inflationary crisis with negative real interest rates and without the collateral damage of a major recession. Markets and central banks confidently anticipate a new, carefree era. If they are right, we can all live happily ever after.
Anatole Kaletsky, Chief Economist and Co-Chair of Gavekal Dragonomics, is the author of “Capitalism 4.0: The Birth of a New Economy After the Crisis” (Public Affairs, 2011).
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