For the last few months markets have been decimated by volatility across most of the globe as authorities took aim at their mutual enemy: inflation. Whilst this has created hugely destructive dynamics across markets and still created winners and losers, there was at least one thing keeping some order: we were all facing the same enemy. The ailment across the United States, Europe and much of Asia was inflation and it tended to be how the medicine of monetary adjustment was dished out that would determine the impact upon valuations of domestic debts, equities, and currencies. The response to the medicine in terms of the impact to growth and unemployment expectations also had some role but perhaps only in justifying how much more of the remedy the host country could bare.
Whilst this has created a chaotic series of events in markets, it is one at least that participants are beginning to understand and aside from the turmoil that the Russian invasion of Ukraine continues to play on the natural gas and wider energy market, was one that had started to become more manageable. However, we have likely entered a new scenario now and one that will demand a new set of rules and monitoring to identify how assets including currencies will perform. This scenario is one in which a key nation such as the United States has reached or passed the point of peak inflation and the rest of the world continues to face an accelerating price level. With the strength of the US Dollar, the US continues to in effect export inflation across the globe thanks to its critical role in global trade. The Fed has continued its commitment to monetary constraint for some time until it is certain that excessive inflationary forces are dead. Whilst keeping the ailment coming, this will likely only increase US Dollar strength and build the rate at which the US contributes to global inflationary pressures.
In the US, the most recent CPI reading has created expectations that peak inflation has passed. There is therefore an expectation that inflation may fall back to target levels slowly from here. However, only yesterday there were credible reports from Citi bank that inflation will hit in excess of 18% in the United Kingdom in January. This report argues that the Bank of England’s own most recent but still harrowing forecast failed to account for the impact of rising energy costs not least due to the huge price rises in wholesale European gas contracts seen so far this week. Arguing that the energy cap will have to rise exponentially into next year, analysts identified an even greater inflationary peak than had been previously expected. Whilst increasing the potential reaction function from the Bank of England this headline is hugely concerning for the real UK economy. The expected economic impacts yesterday undermined any potential advances in GBP from interest rate expectations.
Discussion and Analysis by Charles Porter