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NOT A DAY WITHOUT REASSESSMENT

EMR August 2024

Dear Reader,

FORECASTING DILEMMAS

Due to weak economic growth expectations in the US in early August 2024, stock markets worldwide have been experiencing both great nervousness a well as sharp negative correction. So far in 2024 the correction concerns the US tech giants but not only. According to the news the driver has to be found in economic expectations, and the corresponding policy actions and reactions of the recent past. Why are most analysts worried by negative expectations? Recalling that into July 2024, the underlying focus concerned interest rate cut, in order to propel economic activity. A specific fear was seen in the possibility that the FED would announce interest rate cuts in September, and that it would come too late in order to avoid the feared recessionary phase. A further argument put forward to explain the correction has been the recent US job report. How can this dramatic turnaround be analysed properly?

As an economist with many years of experience, I would like to emphasize that the current scenario is not new to us. We know that the monetary authorities, and a vast majority of analysts continues to emphasize the demand side to the detriment of the supply side. It is a fact that the overwhelming majority are betting on further interest rate cuts to boost consumer growth. Why is pessimism so widespread while economic growth has been quite strong over the last three months? Rising prices are one aspect that might help boost the economic well-being. In any case, the number of redundancies remains rather low.

The reactions of technology driven companies (Apple, Microsoft, NVIDIA, Alphabet (Google), Amazon, Meta Platforms (Facebook), Tesla, Oracle, Samsung and many others) have sizeable gone through a correction phase.

At this juncture we ask ourselves, why does the current scrutiny not focus significantly more on the supply side, as the current main destabilizations setting. Let us ask why, at present, most analysts omit to consider the supply side as a deterministic factor? The difficult, contextual question is how it is possible to reduce inflation by primarily acting on interest rates while crude oil from Russia and other countries is driving up prices? Especially Russia is interested in destabilizing the European and Western economies, while forcing the price of crude oil up and up. The pertinent question refers to the efficiency of interest rate increases to control price increases? The response of industrial products might not be as fast and concrete in terms of substitutes. Thus, the immediate repercussion may be relatively small and difficult to quantify. The problem of understanding and measuring the elasticity of demand to a change in price of a “production good”, like crude oil, is even harder when the product is not a consumer good which is desired for itself, but is a major input for other consumer and/or industrial goods!

Reducing interest rates may, in due course, have the effect of reducing the price of a consumer good, but not the effect of offsetting or increasing the demand for consumer and investment goods. What we are trying to argue is, that interest rate cuts by the Central Banks authorities might produce an inverse effect i.e. a decrease in final demand. Only when the reduction in the prices of equipment causes a reduction in the price of consumer goods, will inflation correct as well.

Even if the actual causes of the recent stock market quake are not entirely clear, it is certain that major investors have speculated e.g. on the yen on a grand scale. How can it be that such a panic-like reaction could and did occur almost out of nowhere? Various explanations are circulating in the press. One of these explanations, which we also consider to be “decisive”, can somehow be explained by the preceding, indeed exaggerated boom in the technology sector and the feared recession possibility in the USA, in conjunction with a further escalation of war in the Middle East. What we fear is that many market participants and commentators have “blindly” followed the temptation of the currency carry trade. This type of trading makes use of interest rate differentials between different currencies to achieve greater profits. Large institutional investors, who move large sums of money, take out loans in a currency with lower interest rates and invest the “borrowed” money in a currency with higher interest rates. This approach has nothing to do with “fundamentally-based” action. What this means for forecasters is nothing other than that the “orchestrated” interest rate adjustments are neither conducive to economic growth nor to combating inflation.

This speculative fuss is problematic when the relationship between currencies changes massively within a short period of time. The question that arises here is: What is the purpose of the central banks’ interest rate adjustments?

SHORT-TERM ASSESSMENT

In light of recent socio-economic trends, we believe that the near-term outlook remains difficult to quantify, both politically and economically, domestically and internationally. We believe that economic growth will remain relatively weak. The extent of the necessary reduction in energy costs remains difficult to predict with the necessary certainty and precision.

The delay or termination of the Russian invasion of Ukraine does not mean that energy prices (the most important determinant of inflation) will fall any time soon, on the contrary, they could even rise for an indeterminable period of time, that cannot be quantified with the necessary temporal and quantitative precision. Interaction with other energy producers could perpetuate fears of persistently high inflation. Related fears could be a challenge for central banks in the context of their interest rate policy decisions. In any case, it should not be forgotten that the predictions of various speculators have not materialized. In other words, we do not expect dramatic changes in the rates of inflation.

MEDIUM TERM

The Presidential election in the United States (on November 5) ought to play a deterministic role. Accordingly, they will somehow determine the economic growth path of the United States, as well as the European and world growth paths. Both candidates do not promise too well. The situation does not speak for a dramatic financial market`s improvement.

It is well known that the U.S. elections are the only national elections that have or can have serious global consequences. In our view, what will matter will be the public acceptance of the preannounced interest rate cuts, which, in due course, may have the effect of reducing the price of consumer goods, but not the effect of offsetting or increasing demand for consumer and investment goods.

An intriguing aspect is going to be the role of the Vice-presidential candidates. At this crossing let us point to the differential focus of the two candidate’s teams. The Trump´s team seems to be primarily focused on the past; while the Kamala Harris´ team is preponderantly interested on the future. Both, the former president and his vice speak the language of disdain for their respective contractors, focusing, for now, on “U.S. nationalism,” while the Harris´ Democratic team focuses primordially on globalism, thus being much more in conformity with the rest of the world, taking into account both American strength in an increasingly globalized world, and other countries on a global scale.

At this juncture we would like to recall Mark Twain saying that “history never repeats itself but it rhymes”. Its meaning is that while historical events may not recur in exactly the same manner there are often similar patterns, themes, and dynamics that can be observed across different eras. The contextual historic lessons we have learned can be summarized as:

  1. Do not sell when markets are down.
  2. Be ready to buy assets at a discount.
  3. Be a knowledgeable investor, tolerate risk.
  4. It’s not true that this time will be different, and
  5. Consider that the market has been more volatile in recent months.

Accordingly, we suggest to quantify the impacts on short-to-medium-term economic activity, focalizing also on the domestic currency and the developments of interest rates.

Suggestions are welcome.

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