Editorial - November



The Federal Reserve has been leading the economic and financial world for decades. The American central bank is the one that triggers rate hikes, that can hurt emerging economies by raising the cost of borrowing in dollars, but also the one that “saves the world” when it decides to flood the market with cheap dollars.

Thus, historically, central banks around the world respectfully await the Fed’s stance and interventions before adapting their own policies.

Today, however, we seem to be experiencing a break in this well-established orderly process of global monetary policy. Why is this? Because the Fed is far from being the first to change its monetary policy.

Long before the Fed made it clear that it was tapering its asset purchases, New Zealand’s Central Bank and the Bank of England were already moving towards a more hawkish stance. In recent weeks, we have seen an increase in rate hikes around the world. In the emerging world to start with, from Poland to Brazil and Russia; then in the developed world, where Canada, New Zealand and Korea entered an active phase of stopping asset purchases and hiking key rates.

« These countries are all worried about the same thing: inflation »

Lucile Loquès

For a long time there were fears that deflation would set in, and now concerns are focused on exactly the opposite: inflation.

A strange and unexpected turn of events: the unconventional monetary policy that was used and abused around the world did not succeed in jump starting inflation. What central banks failed to do, COVID-19, or more precisely, government decisions in response to the pandemic, managed to do. Putting production on hold while flooding consumers and financial markets with liquidity created an imbalance of supply versus demand: an imbalance that is perfectly illustrated by the multiple shortages (against a backdrop of fragmented global value chains).

So the question that is likely to arise is whether the Fed is behind on its monetary tightening process?

It is still too early to say. This inflation could significantly affect company margins and household purchasing power by limiting demand and nipping the inflationary spiral in the bud (and weighing on growth).

Should we prefer inflation implying a strong rise in interest rates, with the risk of equity markets correcting sharply? Or inflation that weighs on growth, forcing central banks to change pace or even direction? A difficult choice if ever there was one. There is perhaps a third way, one that central banks are tireless advocates of: transitory inflation. It is clearly the best of all possible worlds. Supply can adjust to demand, inflationary pressures ease off and growth is preserved. In this ideal world, equity market valuations normalise and the revolution is postponed.

Written by

Director of the International Equities division

November 24, 2021

Covéa Finance, a portfolio management company of the MAAF, MMA and GMF groups with share capital of €24 901 254, incorporated as a single-person simplified joint stock company, registered with the Paris Trade and Companies Register under number 407 625 607 and approved by the French Financial Markets Authority under number GP 97 007.

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