Analysts argue that inflation might remain persistent due to negative supply shocks and bad policies. They warn that central banks’ endeavor to restrain inflation might result in a hard economic landing. On the other hand, investors are wary that the world economy could land into a protracted and severe recession. Well, the world economy is currently grappling with debt crises and financial distress that threatens to hit above the inflation target level.
Investors fear that any portfolio of less risky fixed-income bonds and risky equities might incur losses on bonds. Aside from the excessively loose credit, fiscal, and monetary policies, negative supply chain shocks have contributed to the surge in price growth. The broader sanctions regime in Russia and weaponization of currencies have balkanized the world economy.
De-globalization makes everything worse, following tighter immigration and trade restrictions. The Federal Reserve, the Bank of England, and the European Central Bank are some stakeholders that have already acknowledged the impacts of these negative supply chain disruptions. Experts explain that it is way easier to attain a soft landing from an economic crisis when conditions are stagnant than when it is overheating due to excessive consumer demand.
The Federal Reserve has never attained a soft landing with unemployment below 5% and inflation above 5%. The unemployment rate is currently at 3.7%, while the inflation rate is at 8%. Thus, the monetary policy is subject to fiscal capture. The world economy now faces a growth slowdown, mild financial pressures, persistent rate hikes, policy-rate cuts, and backdoor QE cuts.
From January 2022 through June, US equity indexes like GDOW, 0.35%, the Dow Jones Industrial Average, -0.14%, and the S&P 500, -0.20% fell by more than 20%. Meanwhile, long-term yields like TMUBMUSD10Y 3.743% jumped from 1.5% to 3.5%, resulting in a positive correlation of massive losses for equities and bonds. TMUBMUSD02Y 4.154% bond yields dropped throughout the July to mid-August market rally.
In simple terms, markets maintained a positive price correlation since equities recorded a sharp fall since mid-August, while bonds increased. Generally, the high inflation rate has resulted in tighter monetary policies that cause a balanced bear market for bonds and equities. Global equities and the US cannot even count on a short-hard, or gentle landing. Therefore, stocks will likely fall by about 40% in a severe stagnant debt crisis and 30% in a mild recession.
Overall, signs of recession in the stock markets are increasing. Some include the sharply increasing high-yield spreads, long-term bond rates increase, and sovereign spreads. Others include countries landing into distress, costly governments & households, shadow banks, highly indebted firms, and collateralized-loan-obligation & leveraged-loan markets shutting down.
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