Published on Monday, October 31, 2022

Global | An overly abrupt adjustment process

Fixed income and equity markets alike have reported losses this year, largely due to the doggedness of the monetary authorities in combating rampant inflation, even if that means sacrificing growth.

Key points

  • Key points:
  • The aggressive stance adopted by the central banks is keeping the markets on edge, as they tend to overreact to any event that might push up inflation or prompt a drastic monetary policy response.
  • In the current environment, it is essential for fiscal stimulus policies to be aligned with monetary policy targets in order to avoid any over-reaction by the markets.
  • In recent years, the ultra-low interest rate environment has led investors to seek alternative returns in riskier and less liquid products.
  • This problem became more evident a few days ago in the United Kingdom, when the Bank of England had to step in to provide extra liquidity for funds that use liability-driven investment strategies, aka Liability Driven Investment (LDI).
  • On this occasion, the Bank of England has managed to neutralize the risk by setting up a temporary liquidity facility. Yet the underlying problem lies in the speed of monetary policy tightening, and the low liquidity buffers held by non-bank intermediaries.

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