By Tom Burnett CFA
On June 26, 2022, the Bank of International Settlements issued its 2021-22 Annual Report, along with a strongly worded warning about the serious economic problems associated with inflation and its treatment. The BIS is based in Basel, Switzerland and acts as a central bank for the world’s central banks. Some 63 central banks, including the Federal Reserve, the Bank of England and the People’s Bank of China are contributing members of deposits and capital to the BIS. At the end of May, the BIS balance sheet disclosed assets of more than $500 billion.
The June 26 notice called for decisive action by the world’s central banks to raise interest rates and cool down the global economy until the inflationary pressures are relieved. It argued that the ‘risk of stagflation looms over the global economy’ unless strong and decisive actions are taken. The risk of embedded inflationary expectations is very real unless the central banks make it clear that they are willing to set off a ‘hard landing’ into a recession environment if that drastic set of tools is warranted. Employment levels are at risk, if the downturns prove material, but the price of rising unemployment must be paid if inflation is to be brought back to acceptable (2-3%) levels. According to the June 27 issue of the Wall Street Journal a former BIS official was quoted as saying that a 5% U.S. unemployment rate for several years will be necessary to bring inflation down. If inflation becomes entrenched to the level of influencing union wage negotiations then a severe recession may be required to offset these inflationary pressures. Investors should monitor these central bank statements carefully, since they currently suggest a much higher global interest rate environment than is the market’s existing expectation. Higher rates will slow the global economies and make alternative investments more attractive than equities which will exert negative pressures on the world’s stock markets.
Tom Burnett CFA is Director of Research