by Alasdair Macleod, Gold Money:
World-wide, markets are horribly distorted, which spells danger not only to investors, but to businesses and their employees as well, because it is impossible to allocate capital efficiently in this financial environment.
With markets everywhere disrupted by interventions from central banks, governments, and their sovereign wealth funds, economic progress is being badly hampered, and therefore so is the ability of anyone to earn the profits required to pay down the highs levels of debt we see today. Money that is invested in bonds and deposited in banks may already be on the way to money-heaven, without complacent investors and depositors realising it.
It should become clear in the coming weeks that price inflation in the dollar, and therefore the currencies that align with it, will exceed the Fed’s 2% target by a significant amount by the end of this year.
This is because falling commodity prices last year, which subdued price inflation to under one per cent, will be replaced by rising commodity prices this year. That being the case, CPI inflation should pick up significantly in the coming months, already reflected in the most recent estimate of core price inflation in the US, which exceeded two per cent. Therefore, interest rates should rise far more than the small amount the market has already factored into current price levels.
Most analysts ignore the danger, because they are not convinced that there is the underlying demand to sustain higher commodity prices. But in their analysis, they miss the point. It is not commodity prices rising, so much as the purchasing power of the dollar falling. The likelihood of stagflationary conditions is becoming more obvious by the day, resulting in higher interest rates at a time of subdued economic activity.
A trend of rising interest rates, which will have to be considerably more aggressive than anything currently discounted in the markets, is bound to undermine asset values, starting with government bonds. Rising bond yields lead to falling equity markets as well, which together will reduce the banks’ willingness to lend. In this new stagnant environment, the most overvalued markets today will be the ones to suffer the greatest falls.
Therefore, prices of financial assets everywhere can be expected to weaken in the coming months to reflect this new reality. However, the Eurozone is likely to be the greatest victim of a change in interest rate direction.
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