Risks More Global Than Ever
That said, there’s no question the timing of rate increases is important.
The weight of the world is on the Fed to get this part right. If the dollar gently appreciates against the euro and the yen as a result of slow-but-steady rate increases, and this action doesn’t kill U.S. corporate profits, the EU and Japan will have more time to heal and follow the U.S. lead established through quantitative easing.
On the other hand, rate hikes that are executed too fast or go too far will plunge the developed world into disinflation and risk a revisit of the types of capital market dislocations of 2008-2009.
The EU is teetering on the edge as it is, as the chart below suggests.
But there’s hope:
- First, global corporations are far more nimble than governments, particularly in the U.S., which is paralyzed by congressional polarization and hasn’t had an official budget or significant tax legislation since 2009.
- Second, buying time while banks and corporations heal is a tried-and-true formula that the EU must emulate or risk Japan-type deflation.
- Third, the world is still rebalancing its mix of manufacturing and service-oriented industries, and investment in jobs and retraining will slowly take effect to battle structural unemployment in the developed world.
To repeat what we touched on above, credit and liquidity factors—as in money supply, which have been important and predictive since the 1940s—are moving to center stage.
Meanwhile, price and inflation metrics will stay erratic—possibly for years to come.
Investment models depending on price metrics like sector rotation, momentum and long/short styles are being forced to recalculate. And that’s the price of asking the wrong question.
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