Can inflation woes spark a firestorm in global markets?

The global equity markets are witnessing a sizeable correction. The reason? The credit may become costlier for the companies.

In the past seven days, two data sets on inflation came to light, and both presented a grim picture. The United States, the world’s largest economy, reported that its inflation rose 4.2% in April from the year ago period – a jump that is far higher than many analysts expected. The surge in retail prices in the US is the highest since 2008.

Also Read: Bears grip APAC markets on inflation woes

In the far east, the world’s second largest economy China has seen its producer price index rise by 6.8% in April – the highest pace in almost three and a half years.

This has set off concerns in the global markets. The central banks, the investors fear, would be considering a rate hike after this and doing away with the post-pandemic quantitative easing.

If the central banks would increase the policy rates, it would automatically make the credit costlier for the companies and individuals alike. The credit will become costlier quickly this time than the past incidences, as the central banks across the globe had made sure the policy transmission increases between 2018-20 – when the world was going through downward interest scenario in the face of prolonged slowdown.

This will not only make credit costlier for the companies, but also cause hindrances in the economic recovery after the 2020 recession, also referred to as COVID-19 recession.

And then with rate hike, as the US dollar becomes stronger, there is global imminent sell-off waiting in the wings. As soon as dollar becomes stronger, the returns on investments in other countries for Wall Street companies start diminishing. This triggers a sell-off, and further weakening of the local currency against the US dollar – thereby, setting off a vicious cycle.

In 2013, then Federal Reserve Chief Ben Bernanke spoke about doing away with the quantitative easing which was initiated in 2008. This led to equity market meltdown across the globe.

That was 2013. Almost eight years later, the global markets are more interconnected and dependent on each other. A unilateral rate action by Federal Reserve, for example, will have far-reaching consequences for countries like India. Indeed, central banks are in for tricky times ahead, with a tough task at hand – to strike a balance between economic recovery and inflation.

Also Read: US Fed sounds warning over rising asset prices

(The opinions expressed in this blog are those of the author and they do not reflect the opinions or views of the organisation.)