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The Australian Securities Exchange (ASX) is inching towards “bear” market territory.
By the close of trade, the benchmark ASX200 index was at 6.601 points an 85-point drop, or 1.27 per cent fall.
Selling intensified in afternoon trade.
The ASX200 is now down 13.5 per cent from its all-time high.
The main US benchmark index, the S&P500, entered a bear market on Monday. That’s a fall of 20 per cent or more from its recent peak.
Front and center on the minds of investors across the globe is what the US Federal Reserve will do when it meets tonight (Australian time).
The fear is that it will increase its “funds rate”, equivalent to the Reserve Bank’s cash rate target by 0.75 per cent the largest increase since 1994.
That would be in response to the largest increase in US inflation since the 1980s.
Investors say while we’re used to big market swings, this share market downturn is “different”.
Is it time to ‘break’ the system?
“It is different to the extent that we have an inflation problem which we haven’t seen for quite a long while,” professional investor Danielle Ecuyer says.
“You have to go back to around 2007, back to 1994, back to the early 1980s,” she says.
“I believe that the Federal Reserve will go as hard as it can to really quash the demand in the US economy to get inflation down.
“And it will go as hard as it can until the system starts to break.”
By “break”, Ecuyer is referring to tipping the world’s biggest economy into recession.
That is, with all the uncertainties out there in the ether, there is one rock-hard certainty: Inflation must be brought to heel. There’s no way around it.
The Reserve Bank governortold 7.30 on Tuesday that inflation in Australia could reach 7 per cent by December.
He also said the RBA would do whatever it took to bring it back down to between 2 and 3 per cent. Themes fighting words.
For the US, if bringing about a recession orsomething close to it bringsinflation under control, then the thinking goesthat’s what needs to happen.
One of the world’s biggest investment banks is already calling it:Deutsche Bank says there will be a “major recession” in the US in the next year or two.
And today, the latest reading on consumer confidence by the ANZ Bank shows the mood of shoppers akin to that of a recession.
How did we get here?
I’m in danger of over simplifying things, but here’s a brief history to help explain the current environment.
A US property boom at the turn of the century spiraled out of control and ultimately led to financial institutions having billions of dollars’ worth of worthless financial products connected to said property “boom”on their books.
When this was discovered, the world’s big banks were afraid to lend to one another. Governments responded by financially backing most of the banks, allowing one major bank to fail, and then printing money to encourage lending.
“Cheap” money fueled a once-in-a-generation stock market boom.
It began to run out of fizz heading into the pandemic and, indeed when the pandemic hit, stocks crashed.
Again, though, governments and central banks intervened with more stimulus and cheap money (record-low interest rates).
Managing inflation is the next step
Fast forward to 2022with its growing effects of climate change, supply bottlenecks from a pandemicand war in Ukraine,along with households venturing out from lockdowns and spending stimulus payments, and you’ve got “skyrocketing” inflation.
The problem now is that managing inflation may potentially require significantly higher interest ratesfor heavily indebted mortgage borrowers, businesses and governments.
Investor Danielle Ecuyer says she and others fear the collapse of a major financial institution a bank, for example.
“The more that you create this tightening environment, the financial economy if that’s what you want to call it becomes more stressed,” she says.
“So, you look at how much leverage there is in the system, how much debt there is in the system, then there’s the potential for a hedge fund to go bust, or what’s going to happen in the crypto markets?”
Where is our money safe?
Most have skin in the game.
Last year, according to figures from the Australian Securities Exchange, a record number of younger Australians invested in the share market.
Smart phone trading apps have also led to an extraordinary take-up of crypto currencies like bitcoin (which has dived close to 30 per cent just in the past five days).
And those in or approaching retirement are watching thousands, if not hundreds of thousands,of dollarsbeing wiped off their superannuation accounts.
Once upon a time you could find “safety” in a bank account, but now many standard deposit products return less than a percentage point of interest so you effectively lose money after fees are taken out.
You could be forgiven for thinking there’s nowhere to hide on financial markets.
Catch 22? So, what’s the solution?
If soaring interest rates lead to major economies entering recession, the policy response may well be to provide further stimulus, which would further fuel inflation.
One option is to “allow”the recession to run which would savage business profits and potentially entrench negative economic growth for many years.
The bond market is currently forecasting that the US federal funds rate equivalent to the Reserve Banks cash rate will rise to 4 per cent by the middle of next year.
So, the risk of higher interest rates crunching global economies is real.
There’s one more option
But there’s another option.
What if the supply bottlenecks ease later this year? And what if interest rates don’t actually have to rise too much more before inflation begins to show signs of cooling?
Any share market bounce in the current environment will likely reflect these hopes.
Share markets, over 100years, have shown the capacity to rise over time.
The raw fear now is that if uncontrollable inflation is at the root of this stock market downturn, it’s anyone’s guess as to when the bulk of the selling will be over.
Now, we wait for a monumental decision by the world’s biggest central bank.
Posted† updated
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