Investors have woken up and sharemarkets are sinking

It took a while for investors to grasp the implications of the U-turn in the US Federal Reserve’s monetary policies that occurred late last year. Last week’s nasty sell-off in sharemarkets suggests they’ve finally come to grips with them.

The sudden shift from a “risk on” to “risk off” investment environment is primarily due to the actions of the Fed, whose complacency about rising inflation rates last year was shattered when they kept rising inexorably to levels not seen for 40 years. Other central banks are seeing similarly elevated inflation rates, although generally not quite to the same extent as the US.

In a perverse way, the sell-off in financial markets sends a positive signal that economies and lives are returning, perhaps not to pre-pandemic conditions, but a new and more stable post-pandemic normal. While there is plenty of scope for rates to rise and sharemarkets to fall to deflate the bubbles generated by the unprecedented and ultra-expansionary monetary and fiscal policies implemented in developed economies in response to the pandemic – there are those predicting a proper crash – it should be noted that interest rates remain at historic lows and will do so even as the official rate cycles turns.

The Fed could, of course, get cold feet in response to the markets’ turbulence. It wouldn’t be the first time the Fed backed off and reversed a planned policy course after a market “tantrum.”

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