German scholar: “Toxic combination” is forming for the world economy and markets

2022-05-11 0 By

The following is an excerpt of an article by Daniel Eckert and Holger Chepitz, business editors of Die Welt, entitled “War and Inflation — a combination of the World economic Crisis”.The threat of war and persistently high inflation in eastern Europe have caused deep concern in capital markets, especially as there is virtually no hope of central banks coming to their aid.What does this mean for savers and investors?A toxic mix is forming for the world economy and markets.The threat of war in Eastern Europe gave an extra boost to already high energy costs.This leads to higher inflationary pressures, which in turn limits the central bank’s room for manoeuvre.The world would then be heading for an economic crisis that central banks would not be able to respond to through conventional monetary policy measures.In the past few years, the Federal Reserve, the European Central Bank or the Bank of England have been important rescuers in trouble.Unlike in past downturns, these central banks may now find themselves having to take money with them — or risk fuelling inflation further.As a result, equity investors cannot count on central banks to come to their aid.Germany’s DAX index has fallen about 6 per cent since the start of the year.Other stock market indices have fallen further.The NASDAQ index of technology and growth stocks in the US has fallen 12 per cent.The German tech index TecDAX has fared even worse, falling 17 per cent in a month and a half and now standing on the edge of a bear market, almost a fifth below its peak.In the past, it has not been uncommon for a spike in oil prices to kick off a bear market in equities, and that has not only affected the technology sector but also traditional indices such as Germany’s DAX and the S&P 500.After that, recessions often follow.At present, the situation of energy price rise is very violent.Earlier this week, oil prices jumped to their highest level since September 2014.Brent crude hit a high of $96.16 a barrel.The price of the fossil fuel has risen 22 per cent since the start of the year.But other forms of energy are also on the rise, with European gas prices climbing 15 per cent on top of already large increases in 2021.Rising energy costs have had a significant impact on consumer prices in many countries.In Germany, inflation hit 4.9 per cent in January, more than economists had expected.Energy prices are a big driver.Us inflation hit 7.5 per cent in the first month of the year, the highest since the early 1980s.There was a toxic combination 40 years ago.Back then, the second oil shock pushed western economies into recession, but with inflation in double digits, the Fed decided to raise interest rates rather than cut them.Tighter monetary policy can curb inflation, but it can weigh on economic sentiment and capital markets.The current surge in prices is one of the strongest in decades.That’s partly because energy is such a big part of the shopping basket, and partly because prices have risen so much.The price of energy has gone up very sharply.Wholesale gas prices in Europe are 390 per cent higher than at the start of 2021, while wholesale electricity prices, which are closely linked to gas prices, are 180 per cent higher.Higher fossil fuel prices feed into higher prices for a range of other products, such as agricultural products, as transport and production costs increase, which further spirals inflation.Soaring energy prices have often foreshadowed bear markets in the past, but most analysts remain bullish on stocks for now.Still, the toxic combination can frustrate their predictions.The first banks are already offering more thoughtful advice: Bank of America is advising clients not to buy stocks that have fallen sharply in current conditions.Experts point out that equity valuations have been relatively high recently.Goldman Sachs, an investment bank, is also more cautious than usual.Analysts at The firm cut their year-end target for the S&P 500 to 4900 from 5100.While this year’s return forecast is unchanged and next year’s returns are higher, investors may no longer tolerate such high valuations in the face of higher interest rates.Goldman sachs now expects the Fed to raise rates seven times this year.By raising rates in tandem, the Fed could force the ECB to tighten monetary policy as well, putting more pressure on German and European stocks.This is a toxic combination.