It’s a critical week for the global economy

The key question for the Fed and the other major central banks (except perhaps the ECB, which is grappling with the lingering effects of the war) is whether they can continue to lower inflation rates toward their target ranges of 2% to 3% without triggering recessions .

The fact that the US economy was growing at a respectable rate late last year suggests a soft landing.

That will depend on what the Fed does this week and at future meetings and how it manages the risks between avoiding a rebound in inflation by easing monetary policy too soon and pushing the US into recession by raising interest rates for longer is necessary to construct a soft landing.

The Reserve Bank will face a similar dilemma at next week’s meeting, even though Australia’s headline inflation rate is 7.8 percent, the highest in more than three decades.

More rate hikes appear inevitable, although the RBA has so far been more cautious than its US counterpart, and while inflation rates remain uncomfortably high, December data came in slightly below the RBA’s own forecasts.

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US markets are unconvinced that the Fed can handle the tricky task of delivering a ‘Goldilocks’ result.

The US yield curve is inverted, with longer-dated securities yielding lower than shorter-dated securities. It’s usually the other way around, with longer-dated bonds, like the 10-year note, yielding more than short-dated bills and debentures to reflect the risk of longer holding periods.

Every US recession for the past half-century has been preceded by an inversion of the yield curve, although not every inversion has been followed by a recession. However, markets have priced in a more than 60 percent chance that there will be one this time.

They are effectively signaling that their participants believe that in order to permanently quell price pressures, Fed Chair Jerome Powell and his colleagues are erring on the conservative side, raising rates more than they should and will leave them there longer than they should be avoided if a recession is to be avoided.

All central bankers face the same thorny equation of inflation versus economic growth and avoiding social hardship.

This equation is not easy to solve, as there are external influences on inflation rates in addition to domestic conditions.

The reawakening of the Chinese economy from its zero-COVID hibernation, for example, will help finally deal with the remaining supply chain disruptions that have been a feature of the global economy since the pandemic began and have been instrumental in triggering rampant global inflation .

The global impact of the reopening should also be reflected in an increase in the volume of relatively lower-cost manufactured products, the supply of which has been erratic over the past year due to ongoing lockdowns at China’s factories.

However, the risk of China reopening is that its demand for commodities to support stronger economic growth, particularly its demand for oil and gas, will create a new source of inflationary pressures.

What the leaders of three of the four major central banks (Japan being the other) do and say this week will have a major impact on the outlook for the global economy and markets for the rest of the year.

China’s weak demand last year was an important factor in offsetting the impact of the war in Ukraine on oil prices and on oil prices that could otherwise have been well above $100 a barrel. Central banks, including China, will be cautious about the impact of rising demand for commodities for industrial production.

Supporting the view that the Fed in particular is nearing its peak or “terminal” interest rate rate is reinforced by the fact that if the federal funds’ target range is raised by the expected 25 basis points from 4.25 percent to 4.5 percent the Fed have moved into the “real” interest rate zone, with their interest rate mainly outperforming government bond yields.

Markets are not pricing in any surprises from the Fed meeting at this time.

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Anything less than a 25 basis point gain and a “dovish” comment from Powell at his press conference would shock markets, particularly the stock market, where shares are up nearly 6.5 percent year-to-date and nearly 14 percent since the bottom in October of last year.

What the leaders of three of the four major central banks (Japan being the other) do and say this week will have a major impact on the outlook for the global economy and markets for the rest of the year.

Much depends on whether, with inflation rates appearing to have peaked, they can refine the tapering of their policies and the language around them to something other than a recession and the unemployment and lasting damage to individuals and businesses to generate that recessions bring with them.