The Tribune

ACTIVTRADES WEEKLY

By Ricardo Evangelista

www.activtrades.bs

OVER the last six months, inflation fears have focused the attention of policymakers, economic agents and investors. Central banks have tilted towards a more hawkish stance, while headline-grabbing rises in the cost of living came to dominate the media narrative. In the markets, dynamics shifted dramatically. Risk appetite evaporated, stocks tumbled and bonds were sold.

The return of the old foe, inflation, was - with hindsight - perhaps helped by the mismanagement of central banks and governments. For too long the phenomena was classified as transitory, an idea that fitted in well with policies at the beginning of the COVID-19 pandemic, which were intended to provide stimulus and prevent what would otherwise have been a cataclysmic global economic depression.

However, when doctors prescribe medicine, they should do so carefully so as to prevent unforeseen consequences and undesired side effects. Another common medical challenge is the management of withdrawal symptoms, as patients experience pain and discomfort once doses are reduced and eventually withdrawn. It now appears that the prescription of stimulus measures aimed at mitigating the economic impact of the pandemic may have over-shot its aim, both in scope and duration, contributing to an escalation in consumer prices on a scale not seen since the 1970s. As a result, the actions required to control the spike in inflation, including a tapering of stimulus and monetary tightening, are themselves becoming the cause of a new problem: Lower economic growth.

After months of obsessing over inflation and the need to control it, policymakers started to realise that not only have consumer prices continued to rise but GDP growth is fizzling out, with some countries, such as the UK, recording a contraction during the 2022 first quarter. Against a backdrop dominated by the war in Ukraine, which exacerbated the rise in prices, especially in agricultural commodities and energy, and the return of COVID-related lockdowns in China disrupting the global logistics required for the supply of vital industrial components and consumer goods, the withdrawal of stimulus has so far failed to halt the escalation in prices. Equally, or perhaps even more concerning, are the growing signs of a decrease in economic activity as confidence dwindles among businesses and families.

The months ahead will be crucial. Disappointing corporate earnings reports, released over the past weeks, has triggered alarm bells. In the US, the sharp drop in the results of retailers such as Target and Wal-Mart points to a slowdown in economic activity - an ominous sign of harder times ahead.

The stakes are high. Careful management of policies aimed at controlling inflation will be required to avoid a global recession. The publication of the latest Federal Reserve’s FOMC (Federal Open Markets Committee) minutes revealed such worries among some of the American central bank’s policymakers, who believe that the upcoming slowdown in growth should itself have a calming effect on prices.

Most analysts now expect a pause to follow the two 0.5 percentage point interest rate hikes already planned for June and July. A break for assessment is indeed advisable, because how the Federal Reserve deals with this latest conundrum will determine the economic outlook for the next couple of years.