Keeping policy loose for too long put central bank credibility at risk. Central banks are now fighting back, leading the global economy down a recessionary road. This is not in the price of assets. As growth, earnings and inflation all falter, the negative correlation between equity and bond returns is likely to be restored.
- In the post-pandemic haze, developed market central banks made a judgement call: inflationary pressures would be transitory. It was the wrong one.
- At risk of weakening the credibility upon which fiat currency systems are built, they have had to compensate with hawkish policy of a magnitude few imagined possible.
- Market inflation expectations have been successfully re-anchored. But the repricing of the term structure of interest rates has had profound knock-on effects to all asset classes.
- The fallout will continue. A global recession is not yet in the price of assets. And for spot inflation to return to target, the pain will need to extend beyond financial markets into the economy.
- As economic and earnings growth falter, and disinflationary dynamics set in, the negative correlation between equity and bond returns is likely to be restored.
- The dollar has likely not peaked, though the denouement of the cycle is likely to be associated with the outperformance of the Yen and Swiss Franc.