Jthere is always an offer that symbolizes the end of an era. In the early 2000s, AOL’s merger with Time Warner meant that the dot-com boom was over. The overpriced takeover of ABN Amro by the Royal Bank of Scotland was followed by the global financial crisis of 2008-09. The question now is whether Elon Musk’s purchase of Twitter will be seen as the moment the global economy tipped into recession.
The signs are not promising. Even before Musk made the deal, tech stocks had seen a strong sell-off. The stock market value of Meta, Facebook’s parent company, plummeted $80 billion on Thursday after Mark Zuckerberg’s company reported a 50% drop in third-quarter profits. The reason was simple: advertisers are curbing spending in response to slowing global growth.
Some revaluation of tech stocks was inevitable as economies opened up again after the Covid-19 pandemic. Facebook, Google-owner Alphabet, and Amazon were winners when consumers were confined to their homes during the lockdown and were still going to struggle to sustain such high levels of revenue growth as life returned to normal.
There was, however, another reason for the surge in tech stocks: the easy money policies pursued by the world’s central banks. Ultra-low interest rates and bond purchases through quantitative easing programs meant there was plenty of speculative cash to circulate.
Moreover, it’s not just tech stocks that have exploded. Conditions were ideal for an “everything bubble” in which stocks, bonds and property prices all rose sharply. Over the past few months, it has become clear that the “everything bubble” is over, made worse by central bank policy tightening in response to higher inflation.
So far, it’s really only stocks and bonds that have fallen. There is, however, evidence that higher interest rates are beginning to have an impact on the wider economy. The unwinding of the asset price boom is about to enter a new and far more dangerous phase as central banks test the ability of their economies to withstand higher borrowing costs.
There are fears that the global economy is approaching breaking point. China’s housing slump, the Bank of England’s emergency action to prevent a run on pension funds, and the slump in tech stocks are all part of the same story: a global financial ecosystem fragile put to the test.
BCA Research’s Dhaval Joshi says 2022 was the year when central bank ‘monster tightening’ killed bond and stock market valuations, and 2023 will be the year when that ‘monster tightening’ finally hits the mark. economy and kill profits and jobs.
This may seem like a curious conclusion given that recent economic news hasn’t been all that bad. The US economy rebounded in the third quarter after six months of declining output, while Germany, France and Spain saw modest growth. Unemployment rates remain low, with the UK unemployment rate the lowest since 1974.
The good news won’t last, but while it does, it will likely encourage central banks to maintain tighter policy for longer, so they can be sure they’ve gotten inflation out of the system.
They won’t say the same but they are ready to see the queues lengthen to reduce the upward pressure on wages. The rise in unemployment will not be accidental.
Some inflationary pressures have eased. Oil and industrial metal prices are well down from their peak. Wholesale gas prices were €350 per megawatt hour in the summer, but last week were below €100 per MW/h. Durable goods prices fell as global supply bottlenecks eased and demand weakened.
These price movements point to a marked weakening in global activity over the coming months. But central banks won’t be satisfied until they also see wage inflation come down. This is why the European Central Bank raised rates by 0.75 percentage points last week and why the Bank of England is expected to raise UK borrowing costs by a similar amount when its policy committee monetary will announce its latest decision on Thursday.
Threadneedle Street will make their decision without seeing the full details of Jeremy Hunt’s autumn statement due on November 17, but will know the Chancellor plans to raise taxes and cut spending. If the rumors are correct, Hunt could suck up to £40billion from the economy.
Clearly, this is a critical moment for the Bank. The British economy probably contracted by 0.5% in the third quarter; wage increases are not keeping pace with prices; business bankruptcies are on the rise; consumer confidence is low; housing market activity is down; and world commodity prices fall.
On the other hand, the annual inflation rate is above 10% and the underlying inflation – the cost of living excluding food, fuel, tobacco and alcohol – is above 6%. Official interest rates are now 2.25% and at the height of panic after Kwasi Kwarteng mini-budget financial markets thought they could climb above 6% next year. The expected peak has since declined, but is still assumed to be around 5%.
The Bank faces the difficulty of not knowing when to stop, but what is certain is that the peak in rates assumed by the financial markets is incompatible with a soft landing for the economy. Monetary policy operates with a lag, so the impact of an interest rate hike will not be felt until next year, when inflation declines and unemployment rises.
In truth, the Bank of England has probably already done enough to bring inflation back to its 2% target within 18 months to two years. Rates don’t need to go as high as 5% and if they do, the bank will be guilty of massive overstatement.