Central banks worldwide are trying to rein in expectations of softening inflation while markets are betting against the economic pain the Fed and its counterparts are prepared to inflict. Stocks have edged up with every signal of easing inflation. Powell has just admitted the Fed needs a firmer grip even though it expects to bring the US economy to a standstill.
With terminal levels approaching in this interest rate upcycle, investors betting that central bankers will blink before a serious recession sets in could draw a lesson from a previous premature Fed pullback in the 1980s that allowed inflation to become entrenched. Powell has shared this piece of economic history in testimony of his intent and equity valuations should price in increased credit costs.
Some of this was in evidence in the declines on Indian bourses led by information technology (IT) stocks that have the strongest correlation with the US business cycle. Broader market losses reflect global demand compression and liquidity tightening. Domestic demand in India is unlikely to be insulated against widespread recession and the country’s attractiveness as a destination for capital will be tested next year. Capital flows are entering a new phase after decades of near-zero interest rates in advanced economies. Emerging economies may have to readjust growth strategies dependent on imported capital. They will have to contend with asset price revaluation following a deterioration of their current account balance. Devising policy cushions against financial market volatility will add to the fiscal imbalance created by global health and energy crises.