Post the brutality of September, the markets started on a positive note. Positivity in global markets was driven by the successful evasion of a financial crisis in England.
What happened in England is what we call a Doom Loop!
First, there was a problem - inflation!
To fight it, monetary policy tightened screws to suck out liquidity from the markets and slow the economy down
But then, the new government screwed up by introducing tax cuts, which would boost the economy. It also proposed subsidising power bills, bringing the fiscal deficit under pressure. This caused the currency to depreciate, and the bond market to collapse
A collapse of bond prices would trigger a crisis for pension funds
So the central bank stepped in to buy bonds, which basically injects liquidity into the markets, and further fuels inflation
The Doom Loop - increase rates to fight inflation, and buy bonds to avert a crisis and further fuel inflation. We smell trouble.
Now, on to Doom Loop number two 👇🏼
Moving on to the next Doom Loop:
First, it’s the same problem - inflation!
The Fed got super hawkish to control inflation, raising rates high and fast
This caused the US$ to surge against all global currencies. The parity between US$, GBP and EUR, and the INR at 82 to the dollar have been making news consistently
A weak currency is disastrous during times of high inflation. Take India for example - buying crude and natural gas at high prices, and paying more for it because the US$ has strengthened and the INR is weaker
To combat this, economies worldwide deplete their currency reserves to defend their own currencies. This has already caused a US$ 1 trillion drawdown in global currency reserves (to US$ 12 trillion)
The more US$-denominated assets sold (by depleting currency reserves), the more their supply, and the higher their yields
Higher yields prompt the Fed to get more hawkish, which further strengthens the US$
And we’re in a loop again!
Implication? The fight against inflation has been leading to consequences that can lead to further inflation!
💡 Our View
The current inflation problem is a supply-driven problem. Central banks are fighting this by controlling demand-related factors.
For a structural turn to this problem, we will need to see one or more of the following: the US jobs market cooling off, Russia going soft on the world, OPEC not cutting oil production, and supply chain issues easing out.
Till then, we would be cautious!