That is to say, the specific economic conditions in which we now find ourselves have changed the market as the world has known it for almost a decade. The winds have changed, and Wall Street is getting to know its new master. It’s a painful process.
Now, in one word, the culprit for all of this is inflation.
For the first time since the financial crisis, it has begun to reappear on the face of the earth in a meaningful way. One would think that the prospect of its reemergence after years of waiting would be cause for celebration — but again, against our current economic backdrop, it’s cause for caution.
This is the stew we’re working with here:
- A weak dollar (inflationary).
- An incredibly tight labor market (pushing wages up — so, inflationary).
- Tax cuts, and the borrowing we’ll do to pay for them (inflationary and inflationary).
- The threat of a trade/currency war (inflationary/inflationary).
- A paralyzed Congress (WILD CARD, BABY!).
Some of these elements, like rising wages, occur naturally in a growing economy like the US’s. And others, like our new tax cuts and the debt we’ll have to issue to pay for them, are man-made.
And then there’s the weak dollar, which is both.
Dollar weakness is a factor of a peak in its economic cycle, as well as an administration that can’t stop talking it down. We’ve got a lot of moving parts here.
But put all of them together, and this market is starting to look like an ice-skating rink covered with a thin layer of olive oil. For even the most experienced figure skater, it’s going be difficult not to lose control and fall.
Messing with gravity
For years we’ve known that this moment — whenever we got to it — was going to be a delicate one. How could it not be? What we are experiencing right now is the economic equivalent of watching the laws of gravity change.
At the moment, the entire world is in the process of reversing years of unprecedented, coordinated, low-interest-rate policy. No one was 100% certain what it would all look like while it was happening, let alone what the world would look like when we were done.
What we did know then (and do know now) is that when the gravitational pull changes, money will begin to flow around the world at different speeds and in different directions, headed to destinations unknown.
Adjusting to the world’s new money flows comes with a measure of uncertainty. When rates start to rise because of a tightening labor market and rising wages, how can anyone be sure when they’ll stop, especially when there are other inflationary elements at work in the economy? Will the Federal Reserve have to respond with rate hikes? If so, how many?
This is regime change.
Across Wall Street, volatility models are busting, and technicals are changing, and strategies are being thrown out as the entire plumbing of the global economy is being reconstructed. For traders, this means the buttons on the machine that is the stock market don’t do what they used to. Everything must be relearned.
On a grander scale, no one knows how other governments will respond to these new inflationary conditions. Take, for example, dollar weakness — or what Joachim Fels, the global economic adviser at Pimco, is already calling a “cold currency war,” in which the US tries to keep its currency low and the rest of the world races lower to stay in step.