Whilst the Russian invasion of Ukraine dominates the mainstream news the investment community is focussed almost entirely on inflation and the US Federal Reserve’s reaction to it.
On 21 March Jerome Powell, the Chairman of the US Federal Reserve said that the Fed must move “expeditiously” to raise rates and possibly “more aggressively” to battle soaring inflation, after the US Fed had increased interest rates by only 0.25% the previous week.
Given the importance of the US to the global financial system and the all powerful role of the US$ currency, the impact of the decisions made by the US Federal Reserve have an outsize impact by comparison with other Central Banks (for example the Bank of England).
There has to be a risk that the US Federal Reserve carries on raising interest rates in the US to cool its overheating economy and that this has the knock on impact of causing a recession in other, weaker economies. As US interest rates rise this will cause the US$ to strengthen against other currencies, increasing the relative cost of imported goods priced in dollars. Central banks in affected countries will come under pressure to increase interest rates to shore up their own currencies regardless of whether their local economies are able to cope with higher rates.
Consumers globally are under pressure from sharp increases in energy costs and as this feeds through into food, goods and services more broadly, it is unlikely that wage increases will keep pace. If we then factor in higher interest costs on mortgages and car loans this can be expected to leave families forced to rein in their discretionary spending with an associated impact on domestic GDP and potentially triggering a recession.
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