The catalysts for the global market rout of the past few days were almost all to be found in China. But attention has already shifted to the West, and the catalyst for what comes next may well come from Jackson Hole, Wyoming.
For good reasons, the Federal Reserve would like to raise interest rates. It has made clear that US unemployment is no longer a reason to keep rates at emergency lows, and has prepared for a rate rise next month. That has its own effects, independent of the signs that China’s authorities are not, after all, able to micromanage every move of their economy and markets. Global trade has slowed, as has investment.
While stock markets panicked today (before US stocks clawed back some lost ground), the markets for bonds and the dollar gave the best clues as to what happens next. Forecasts derived from US bond prices suggest that expected average inflation over the next decade has just dropped below 1.5 per cent, for the first time since May 2009, during the worst of the global financial crisis.
Against the other main developed markets, the dollar has fallen sharply even as its gains persist against the currencies of big commodity exporters.
Expectations
Inflation expectations mattered critically to the Fed under Ben Bernanke. Twice since the crisis, it resorted to fresh doses of quantitative-easing bond purchases in response to falls in inflation expectations far more mild than this current deflation scare. When the Fed eases, or signals easing, and US rates stay low, the dollar weakens.
So the bond and stock markets are calling that the Fed cannot go through with a rate rise, and are acting accordingly. A newly dovish Fed and a weaker dollar would support US company earnings, and relieve many around the world. This helps to explain the US stock market’s recovery after its terrible opening. It also implies that the message from the Fed’s annual powwow in Jackson Hole this week will be critical. If the Fed re-emphasises its desire for a rate hike, the market sell-off could re-intensify; if it bows to market pressure for now, the sell-off could abate. Copyright The Financial Times Limited 2015
