When we just entered the year 2022, it was hard to guess what its main motive would be, but now that we are only one week from the last summaries of the year, it is safe to say that what characterized the last year was the fight against inflation.
So how did we get here? When the year started, inflation stood at 7%, with it gaining momentum towards the end of 2021. The main increase lay in the low supply, with commodities being the main gainers of 2021 and the beginning of 2022.
In addition, Russia’s invasion of Ukraine (which continues even today) brought with it another increase in goods, both in food such as wheat and corn, both in energy such as and and even other goods such as metals and gases used for industry.
To combat rising prices, central banks around the world decided to tighten monetary policy. In other words, the central banks, led by the US Federal Reserve Bank, raised interest rates and began reducing their asset balances, thus making money more expensive. Loans became more expensive and deposits began to provide a better alternative to investments.
It can be said that the tightening of monetary policy came late, as the Fed only started raising interest rates in March of this year, when the index for tomorrow showed an increase of almost 8%, and reached a peak of 9.1% four months later.
Despite the initial increase, real interest rates were deep in negative territory. The Fed, realizing that it started raising interest rates too late, quickly narrowed the gap and began raising interest rates at the fastest pace in decades (!) when the Fed raised interest rates by 425 basis points since the beginning of the year.
The increase in interest rates began to do its job, when a slowdown in the rate of increase in price indices was recorded, and the latter recorded an increase of 7.1%, slightly above the annual price increase recorded about a year ago.
Where are we today? As mentioned, the Fed raised the interest rate to 4.5% levels and is in the midst of reducing the balance sheet, with a repayment of 90 billion dollars in bonds every month. The bank’s expectations are for an interest rate target of around 5%, which means that there are still interest rate hikes left in the upcoming decisions.
The European Central Bank raised it to the level of only 2%. The European Bank is dealing with higher inflation than the US, especially in light of energy and electricity prices that soared following the war in Ukraine. Despite this, the Bank was in no hurry to raise interest rates and reduce its balance sheet, mainly because of the weak links in the union such as Italy, which will have difficulty paying its debts in a high interest rate environment.
The bank is expected to continue to raise interest rates towards 3% and northward and start reducing its balance sheet soon and it will be interesting to see how the economically weaker countries in Ehud will deal with the additional interest rate increase.
The Bank of England raised the rate to 3.5% and began reducing its balance sheet. In the past I referred to the failure of the Liz Tars administration and the saga in which the bank was forced to intervene in the bond market despite its desire to reduce the balance sheet.
England now has a more financially responsible government and the central bank has returned to actively reducing its balance sheet. Here, too, the bank still has interest rate increases to 4.5%, but on the positive side, it seems that inflation is nearing its peak.
How did it affect the markets? As I mentioned earlier, the tightening of monetary policy made loans more expensive and brought with it safe investment alternatives with a good return for the solid investor. Following these, stock prices were repriced as the cheap money era multiples were changed to the expensive money era.
ETFs on unprofitable companies lost about 60% on average in the past year when the sales multiples were reduced up to 5 times. Profitable companies also lost their value, when the value indices lost over 10% during the last year (according to Goldman Sachs data).
It strengthened against the broad basket of currencies, and the dollar index recorded a record last seen at the end of the dot.com crisis in 2002. Solid investors were also hurt when they recorded the weakest year ever, as of October.
The risk assets were obviously hit the hardest, when the crypto market experienced a particularly difficult winter with sharp declines and a crisis that caused a wave of bankruptcies.
What happens next? Inflation is expected to cool down. Last Friday, the University of Michigan’s were published, which reached the lowest level in 11 months with a reading of 4.4%. The call for five years ahead is still not encouraging enough, when it predicts an increase of 2.9% which is above the Fed’s target, but there is undoubtedly some optimism about inflation in the coming year.
But, with the increase in the price of money brought with it by a cooling in inflation comes a slowdown in consumption which leads to an economic slowdown. Financial stability is starting to be undermined, especially when you take into account that real estate prices, which directly affect the feeling of wealth, are starting to fall.
Life expectancy has hardly changed for the average consumer who is used to low interest rates, and to maintain it the consumer is asked to use savings and increase credit expenses. In a situation of monetary tightening, this is unwise behavior that could lead to a deep crisis.
In almost every survey, economists and analysts predict a recession in the coming year, the only question is – how deep will it be? We will receive the answer during the next year.