Global growth or stagflation?

Traders began this November, historically the best month for equities, by largely stepping out of the market because nobody wanted any baggage ahead of the Federal Reserve Bank’s policy meeting, due to conclude on Wednesday. Bets are that the Fed will formally acknowledge that the time to pare back its pandemic stimulus programme has come, and begin unwinding its $120 billion in monthly asset purchases before the year ends. Strengthening inflation in the world’s largest economy has led leading investment banks like Goldman Sachs to pull back expectations of a rate hike from September 2023 to around July 2022; and the market has pretty much priced in tapering in the days and weeks ahead.

The dollar index, which tracks the greenback against a basket of six major currencies, started the new month with a 0.28 percent drop on Monday, but only after rising 0.82 percent on Friday, its biggest daily jump in more than four months, after the Personal Consumption Expenditures (PCE) surged 4.4 percent. And since PCE is the Fed’s preferred inflation measure, it’s no surprise that Mr Market has assigned a 50 percent probability of a 25-basis point hike by next summer. With monetary policy in the UK (United Kingdom) and Australia also in focus this week, and the former more or less having telegraphed a rise while the latter mulls withdrawing its own bond-purchase program, there seem clear signs that the so-called reflation trade has raised prices enough in different countries for the pandemic-induced recession to be safely behind us.

But do rising prices alone suffice to confirm a return of growth to the global economy? Sure, most individual economies that set the direction of the global economy are growing, even if there is a very clear low-base effect, and that’s led to a general rush in commodity prices, but is the turnaround really as across-the-board as the market’s herd behaviour seems to imply at the moment and are all important indicators pointing in the same direction? If sustained growth has indeed returned to the world’s leading economies, then there’s much good news in store for smaller ones as well, especially emerging markets, as international trade picks up, employment increases, and the spillover effect begins. But if it has not, and the growth spurt turns out to be temporary, then a lot of over-eager investors are just waiting to get their fingers burnt all over again.

If you take your feed from the broker across the street who counts on roaring demand in Brent crude to flash strategic long signals for commodities, then your optimism is justified. But if you scratch just a little beneath the surface you’ll see that there might still be enough anxiety in the market to keep long-term bulls cautious for the time being. China, the world’s second-largest economy, was the first to come out of below-zero growth that the pandemic plunged the whole world into, but as the others are recovering it is going back to new variants, fresh lockdowns, and a very visible slowdown of the economy.

That wouldn’t be a very big deal for the rest of the world if the Middle Kingdom weren’t so intricately linked to all of it. And since property and energy woes slowing China down are also affecting international trade, the recovery-all-around story isn’t yet as rosy as it is being made to sound. That is why seasoned investors and traders always follow the Baltic Dry Index (BDI) like a hawk. It is a proxy for global trading activity because it is a shipping and trade index created by the London-based Baltic Exchange and measures changes in cost of transporting raw materials like coal and steel. That makes it a crucial leading indicator for market traders because of its ability to reflect demand and supply for the most important ingredients in manufacturing.

It called the 2008 recession pretty accurately and, more recently, it collapsed by more than 70 percent between September 2019 and January 2020, signalling very sharp contraction just as the Covid-19 pandemic was taking hold. It rose more than 133 percent between early June and early October 2021, solidifying expectations of a return of good times. But following the early October peak it tanked approximately 38 percent by the end of that month. So far the bad health of the Chinese economy, especially the latest disappointment in October manufacturing data, is the biggest reason for this decline in the dry bulk sector, which one London-based shipping brokerage house said was already “exasperated due to the Evergrande situation”.

But as persistent rise in Chinese inflation just as production has fallen to the lowest level since at least 2005, barring the 2008 recession and the 2020 Covid trauma, more or less confirms stagflation in the second-biggest economy, it’s only a matter of time before traders, investors and central bankers begin wondering if the price hike, absent enough accompanying growth, in the US also implies an overheating as opposed to a growing economy.

If it turns out to be the former, then a drop in shipping and trade, as indicated by the BDI, could just have warned about painful stagflation in the global economy.

Copyright Business Recorder, 2021