Is the market starting to think ahead to a post-crisis period?

Last week was constructive for equity markets, which gained between 2% and 6%, depending on the marketplace, over the week as a whole. However, no real substantive changes were seen. The market is still trying to gauge just how determined central banks are in combating inflation. Every word is being scrutinised and every number analysed to calculate the likely scope of rate hikes.

In the US, Jerome Powell’s testimony before the Senate Banking Committee was the main source of information last week, although very little news was forthcoming. But the Fed is equally aware that a soft landing for the economy will be difficult to achieve. Powell also reminded his listeners that while the Fed does have a real mandate to drive inflation down to 2%, many factors outside of its control will be decisive as to whether it can hit this target or not.

As stated in earlier publications, the only policy instrument available to central banks in its fight against inflation are rate hikes, but these also have the effect of reducing demand across the economy. This alone does not address the real factors driving inflation higher at the moment, which are fossil fuel prices, grain prices and supply chain bottlenecks. Government measures would be far better as this would allow the offending inflation components to be perfectly targeted and could be enabled or deactivated at will.

Among the most specific measures, a broad-based temporary reduction in fuel and gas duties would probably be most appropriate. In extremis, price controls – even temporary ones – would also help manage the transition. In the longer term, massive investments in renewable energy are vital but cannot address the inflation issue in the short term.

The market is today pricing in a near-certain recession in the US economy. This will be costly for governments because a weak economy means lower tax revenues.

Yet targeted price controls by governments – partly financed by windfall taxes on companies gaining from the heady price conditions – would mean that central banks could be less hawkish in raising interest rates and cut the economy some slack. A scorched earth policy is rarely the right one.

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