The rules of the game this year were supposed to be simple. The process of disinflation was supposed to continue, which would lead major central banks to cut interest rates several times. The US economy in particular should have held up well and given the Fed some breathing room to work with Powell and company. We look forward to supporting economic conditions.
Instead, we are starting to see recent data pointing to a deteriorating US economy. On the other hand, Europe and the United Kingdom have shown some resilience this year. This has given the European Central Bank and the Bank of England at least some extra time to navigate their policies.
As for the disinflation process, we have kind of stopped it over the past month or two. The good news is that we have seen a reduction in price pressures over the past year across the world. But the “easy” part was precisely that, getting the inflation rate down to about 3%. The “hard” part is in the here and now, trying to get that back to about 2%.
Amid base effects and such, major central banks claim that inflation will start falling again in the latter stages of this year. It may happen, but let's not forget that policymakers have never had a good track record of naming these things. Remember how much they insist in 2021 that this was all meant to be Fleeting? It has now been three years since that day.
Anyway, all of this brings us to where we are now when we look at the global economy. This faces the possibility that inflation will remain on the higher side for at least the next four to five months while economic conditions slow further. Or more specifically, while the US economy slows further.
The latter could prompt the Fed to cut interest rates sooner, and you think that would be good news for broader markets and risk sentiment.
However, it's very much a balancing act at the moment. It's only good news as long as it's accompanied by the right reasons. Otherwise, not much. If major central banks are reluctant to budge in the battle against inflation, this would make the situation even worse. If they don't cut interest rates while the economy slows further, that's not a positive recipe for risk trades.
That screams Stagflation This is something that market players should take note of. That is, if they haven't already.
This is not the first time that the rules of the game in the markets do not seem to be in place Which basic. It certainly won't be the last.