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Descending From Extremes Is a Rocky Process

To understand the current volatility, it helps to get reacquainted with just how out of whack things were coming into 2022—in terms of both magnitude and timing.

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High inflation is a symptom of an economy that’s in transition, an economy that’s out of whack. Supply and demand are misaligned, and prices must move substantially to restore equilibrium.

Inflation is also, understandably, the current market obsession. Friday brought more bad news on that front, as U.S. inflation printed at 8.6%. But it also explains why apparently good news, such as the last U.S. payrolls report, is also greeted as bad news by investors.

Today, most people feel secure in their jobs and confident when asking for a pay raise. U.S. unemployment is back near its very low pre-pandemic level, at 3.6%. Long-term jobless claims are at a 53-year low and wages are growing at 5% per year. Eurozone unemployment, at 6.8%, is lower than it has ever been. Low-paid workers in Germany are set to receive double-digit pay hikes this year. Despite this, the first half of the year has been characterized by volatile, crashing stock markets.

If inflation at 8.6% is a measure of the current economic disequilibrium, could a 20% stock market sell-off, and the recent level of volatility, be commensurate with that?

Market participants can benefit from getting reacquainted with just how out of whack things were coming into 2022—in terms of both magnitude and timing. It can help us get perspective on how big this inflation shock is, how challenging the subsequent normalization might be, and how much market volatility it could take to get through it.

First, let’s think in terms of magnitude.

A decade ago, the $3 trillion or so in fiscal stimulus thrown at the Great Financial Crisis (GFC) appeared era-defining. However, the International Monetary Fund’s most recent figures put global fiscal measures in response to the COVID-19 pandemic at $11 trillion. It estimates that the U.S. spent 5% of GDP to counter the GFC, but 26% in response to the pandemic. The COVID response is set to be four times higher than the GFC response, on a global economy that is only 32% bigger now than in 2008.

As for monetary stimulus, remember the shock when the assets on the balance sheets of the Federal Reserve, European Central Bank and Bank of Japan jumped from $4 trillion to $6 trillion during the GFC? When that figure appeared finally to peak in 2018, at $15 trillion, the number seemed almost surreal. But as we entered 2022, those balance sheets groaned under $25 trillion of assets.

This led to financial conditions that were almost unimaginably accommodative, even after a decade of loose policy.

The U.S. 10-year real yield—a reflection of how much one might expect to be paid, after inflation, for lending to the U.S. government for a decade—hit an all-time low of almost -1.2% in summer 2021. According to Bloomberg, there was more than $18 trillion of negative-yielding debt in the world at the end of 2020. A full 40% of outstanding government debt was below zero. Even at the end of the first quarter of this year, $3 trillion of bonds still traded with negative yields.

And this all fed into stock markets, too. At its peak at the end of last year, the S&P 500 Index was up almost 45% over its pre-pandemic level, according to FactSet. The Russell 1000 Growth Index was up more than 60% and the NASDAQ 100 Index 73%. Let me repeat that: These are not returns from the trough of the COVID-19 crisis but from the pre-crisis peak—when many investors were fretting about stretched late-cycle valuations.

With financial conditions like these, is it any surprise we have inflation that needs to be tamed?

Now let’s think about timing.

For most people, most of the time, a recession has meant worrying about losing your job, worrying about personal finances, and cutting back hard on spending. The COVID-19 recession saw almost the opposite.

The U.S. Household Savings Rate, which has hovered around 5% for most of this century, spiked to almost 35% in the first weeks of the pandemic. That was partly due to early concerns about the economy, but it was mostly because there wasn’t much to spend money on during lockdowns—bolstered by stimulus payments, that’s why it spiked a second time, to 25%, in early 2021. Disposable personal income leapt from the long-term trend level of around $18 trillion to almost $22 trillion around the same time. Spikes like that have never been seen before—let alone during a downturn.

The savings rate has declined over the past year, but that is likely due to a return to spending that reflects pent-up demand and healthy consumer confidence, which in turn reflects the strong jobs market detailed at the top of this article.


To protect the economy from an unprecedented shock, governments and central banks flooded it with a stimulus of unprecedented magnitude. This helped ensure that, while deep, the COVID-19 recession was short. But it also caused a cyclical timing problem: The economy is still trying to digest those measures two years after the recession ended.

High inflation is one symptom of that indigestion. We believe that adds urgency to normalization measures, but the sheer magnitude of the disequilibrium means that normalization is likely to take some time.

The good news is that, in our view, the consumer and the broader economy are somewhat better prepared than in past cycles to absorb a lot of financial tightening. However, this cycle is so far out of whack that we remain far from sure that the recent sell-off has brought things fully back in line.

The end of this policy mix was inevitably going to be an intense and challenging process. This out-of-whack set of economic dynamics is going to take more time to normalize.

Joseph V. Amato , June 2022

Article also available in : English EN | français FR

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