Monthly Market Update: Volatility and hope

Tue 14 Mar 2023

Volatility. The end of the macroeconomic “Great Moderation”. This was our theme entering 2023. We are already seeing data that is volatile, and contradictive. US Housing and manufacturing are at 2008 levels. Yet consumption data for January was one of the strongest on record. China is reopening fast. Yet, there are no traces of inflation. Japan is experiencing inflation for the first time in decades. However, for the time being the Bank of Japan is insisting on yield curve control (i.e. money printing). This volatile and unpredictable macroeconomic backdrop is also non-directional.

Now consider a key policymaking organization like the US Federal Reserve. Every month, it waits for 2-3 key pieces for inflation data, but also other numbers, indicating the general strength of the economy, such as retail sales, employment etc. What happens when the figures are so unpredictable? Or when they are not telling a coherent story? Interest rates are a longer term consideration and can’t go up and down at every meeting. The Fed needs a direction, even if the data can’t provide it. Thus, data-dependency may provide a good “objective” narrative as to why interest rates go towards a particular direction, but when the story isn’t clear, it is ultimately it’s people who decide, and people have biases. Economists, in particular, are a profession notorious for biases, usually created in academia.

This creates confusion for markets, who may see the same data and reach different conclusions. The Fed has indicated that it will proceed with single rate hike instalments. After the latest data, double rate hikes are back on the table.

So, the inescapable conclusion is that there’s a growing probability that policymakers will miss the mark. They will either over-tighten (more likely) or under-tighten, each one with a different set of repercussions. The same goes for every major policymaker, not just central banks.

Our world that is gravely imbalanced, and inefficient not necessarily because the economy can’t find an equilibrium. It’s shifting supply chains that is the problem. A better explanation is that the great nations of the world persist that antagonising each other and undoing the decade-long benefits of globalisation is somehow good for their internal electorates. We are quickly moving towards a bi- polar world, not too dissimilar from the one we grew up in.

Inescapable conclusion number two: if indeed its geopolitical imbalances that hinder sanguine policymaking, expect this to last for some time.

Yet, those looking for a glimmer of hope should look no further than Europe, and, more recently, Great Britain. The Government, despite its commanding majority in the Commons, has changed its strategy. It no longer tries to thumb its nose at its neighbour, even if it is egged on to do so by some MPs and part of its core electorate. As a first result, last week it achieved a breakthrough, the “Windsor Framework”, a workable deal for Northern Ireland. The deal itself is of limited impact, an incremental first step towards averting a trade war. More market access for the financial sector will be a difficult task to achieve, but when people negotiate in good faith anything can happen.

Inescapable conclusion number 3: At an age when the West has forgotten war, electorates will eventually see that confrontation results in worse economic outcomes and it was international cooperation that increased their wealth.

George Lagarias, Chief Economist, UK