Fractured markets: the big threats to the financial system | FT Film

Summary

The global economy is facing significant challenges, including high inflation, rising borrowing costs, and the possibility of a recession. Central banks, especially the Federal Reserve, are focused on controlling inflation, even if it means a weaker stock market. Emerging markets are vulnerable to debt crises, and speculative excesses in tech and crypto markets may cause future instability. The ongoing geopolitical crisis, particularly in Ukraine, adds further economic strain. While central banks have better tools than in 2008, the risks remain high, and financial stability could be at risk unless inflation is managed effectively.

Takeaways

• 😀 The Federal Reserve is focused on controlling inflation and is willing to accept a weaker stock market to achieve this, even at the risk of a recession.
• 😀 Jerome Powell emphasized that there is no 'painless' way to reduce inflation, drawing parallels to the mistakes made in the 1970s when policymakers prematurely eased policy.
• 😀 Central banks, like the Fed and the Bank of England, are prepared to intervene if credit markets seize up, but there is significant concern about how severe the crisis could be.
• 😀 The Bank of Japan's bond market remains a significant concern, with low interest rates and inflation posing challenges. Investors worry about how the market will react if inflation persists.
• 😀 Emerging and developing economies are at significant risk due to rising borrowing costs, a strong dollar, and insufficient fiscal resilience. The IMF reports that 60% of low-income countries are near or at debt distress.
• 😀 Ultra-low rates have fueled speculative excess, particularly in unprofitable tech companies, private venture capital-backed firms, and the cryptocurrency market.
• 😀 In the U.S., the private market for unlisted tech companies is expected to face difficulties as rising interest rates trigger down rounds, where companies raise funds at a lower valuation.
• 😀 The UK mortgage market faces risks as rising interest rates could cause short-term fixed-rate mortgages to become variable, resulting in higher payments and potential stress on banks.
• 😀 The shift from low interest rates to higher rates has disrupted financial markets, causing asset valuations to contract and creating a new paradigm of higher rates and inflation for a prolonged period.
• 😀 The IMF has warned that the worst is yet to come for the global economy, with risks of defaults, hidden leverage, and further economic turbulence as central banks continue their tightening policies.

Q & A

What is Jerome Powell's stance on controlling inflation, and how does it impact stock markets?

Jerome Powell, the Chair of the Federal Reserve, is committed to controlling inflation even at the cost of a weaker stock market. He has acknowledged that there is no painless way to reduce inflation and has made it clear that he is willing to accept stock market declines to achieve this goal.

Why does Powell refer to the 1970s economic period when discussing inflation?

Powell references the 1970s as a cautionary tale about the dangers of prematurely easing monetary policy. During that time, inflation spiraled out of control because policymakers eased up too soon, a mistake the Federal Reserve is determined not to repeat.

What risks are associated with the Japanese government bond market?

The Japanese government bond market is an outlier, with low inflation and extremely low interest rates. There is concern that if inflation rises, the Bank of Japan may struggle to unwind its policy without triggering a crisis in the bond market, which has been a point of speculation for years.

What is the potential issue with emerging markets as borrowing costs rise?

Emerging markets are highly vulnerable to rising borrowing costs and a stronger dollar, which makes it harder for highly indebted countries to manage their finances. The IMF reports that 60% of low-income countries are already in or near debt distress, raising the risk of defaults.

What impact could the rising borrowing costs have on unlisted tech companies in the U.S.?

Rising interest rates are expected to spill over into the private tech sector, particularly affecting unlisted tech companies. Many of these companies raised funds at high valuations during the boom years, but as borrowing costs increase, they may be forced to accept lower valuations in future funding rounds, known as 'down rounds'.

How could the UK mortgage market be at risk due to rising interest rates?

In the UK, most mortgages are short-term, and with the Bank of England raising interest rates aggressively, many mortgages could shift from fixed to variable rates, resulting in significantly higher monthly payments for borrowers. This could cause financial strain on households and banks alike.

How has the era of low interest rates influenced financial markets?

The era of low interest rates created an environment conducive to risk-taking, encouraging investments in speculative areas and the use of leverage. With borrowing costs rising, previously hidden leverage and speculative excesses are now exposed, potentially leading to financial instability.

What concerns exist about the potential for hidden leverage in the economy?

There are concerns that hidden leverage in the financial system, which policymakers have not yet identified, could lead to unforeseen crises. As interest rates rise and financial stress increases, previously overlooked risks may emerge, causing shocks in various sectors.

What are the risks associated with the global inflation outlook?

Global inflation remains a significant concern, with inflation rates still well above target in many major economies. Although there are signs of a slight pullback in inflation, particularly in the U.S., the overall economic environment of high rates and inflation is expected to persist for the foreseeable future.

What might trigger a resurgence of labor movements and wage increases?

As inflation remains high and economic pressures continue, there is a possibility of a resurgence in labor movements and wage demands. The long period of wage stagnation since the 1980s could shift, with workers pushing for higher wages as part of broader social and economic adjustments.