America, China, Europe, and Emerging Countries – Same Economic Problem, but Different Destinies.
3 major consequences for the financial markets.
With the COVID-19 pandemic, all the economic zones of the world were confronted with a similar situation. The response was similar. With what seems to be the exit of COVID-19, and with the war in Ukraine, the situations become totally different.
All areas have the same economic problem, but the fates will be different.
The economic crisis affects America, China, Europe, and the emerging countries that do not produce raw materials. In each of these areas, a recession is feared. But these recessions will be different and will not be similar. In fact, the responses will also be different.
This gives a first explanation for the violent variations of the currencies of each of these zones.
China
Let's start with China. China's main problem right now is COVID-19. More exactly the zero COVID policy that Xi Jinping has locked himself into:
The lockdowns in major cities in China and in major manufacturing regions have brought entire sectors of the economy to a standstill. This has logically led to a collapse in consumption and a collapse in production.
In China, the central bank is less concerned with inflation than with growth. This is a key issue for Xi Jinping as the Communist Party Congress will take place at the end of 2022. A congress that must confirm him for a third term at the head of China.
The Chinese central bank is starting to take measures to ease interest rates, especially for real estate loans.
America
In America, the problem is inflation. This one is galloping. It is still 8.3% in April 2022. It is the highest it has been in 40 years. This inflation causes brutal pressure on the purchasing power of Americans.
This has two major consequences in America:
The discontent of the households which can turn into a sanction vote during the Midterms which will take place at the end of 2022. This is a major issue for Joe Biden if he wants to continue to advance his political agenda.
A fall in consumption that could lead the American economy into recession. For many economists, America will not escape the recession in the coming months.
The Fed has reacted late, too late even. Its short-term concern is more inflation than the slowdown of American growth. The Fed is going to have to act like a race car driver who has to negotiate a sharp turn after being late to brake at the end of the straight:
You can therefore expect the Fed to continue to raise rates quickly, even if it means lowering them in a few months when inflation has fallen back and growth has slowed.
Europe
For Europe, the problem is rising energy and food prices. Europe, with Germany in the lead, is being hit hard by the increase in Russian oil and gas prices, on which it is heavily dependent.
Inflation is therefore also a major issue there.
But unlike America, Europe's economy is not running at full speed. While Northern Europe is at full employment, Southern Europe is still struggling.
The risk of a recession is very real.
This is why the ECB is reacting less quickly than the Fed and will only raise rates from July 2022 onwards by ending negative rates. The ECB's great fear is that it will plunge the economy into a damaging slowdown.
Emerging countries
The situation in the emerging countries must be separated into two parts. On the one hand, the oil and energy-producing countries. For these countries, rising energy prices are an ideal opportunity to earn foreign exchange. Their economies are booming and they can handle the inflation.
On the other side, you have the other emerging countries, those that do not produce oil or gas. For these countries, it's a double whammy: rampant inflation and a sharp economic downturn because of inflation.
The central banks of these countries are stuck:
If they raise rates, the economy plunges.
If they lower rates, inflation explodes and their currencies collapse.
Only India seems to be doing well for the moment. But we will have to see if this first observation is confirmed in the months to come.
Final Thoughts
We can clearly see that each zone is facing its own problems and that there can be no uniform answer to different problems. Each economic zone will therefore try to save its own skin and avoid a recession with its own means, without worrying about the impact of its decisions on the rest of the world.
This will lead to three major consequences:
An uncertain economic situation in the world in 2022 and for a good part of 2023.
High volatility in foreign exchange rates.
High volatility in stock market indices and interest rate markets.
Caution is therefore required for all investors.
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