Volatility and Inflation Require Constant Monitoring
The Evolution of the Chinese Economy and Evergrande
The situation with Evergrande in China, the persistent rise in commodity prices, growing inflation in the United States, labor and supply shortages across multiple economies, the evolution of the pandemic, and central bank interventions are all contributing to increasing market uncertainty. Volatility and inflation will require heightened vigilance. In this context, the key question is: what will happen to interest rate differentials between economies as the world emerges (or not) from the pandemic?
A default by China’s Evergrande Group would be dangerous for the Chinese real estate market, a sector that accounts for nearly a quarter of the country’s economy. While exports help offset issues in the real estate sector, this strength stems from global supply chain backlogs and pandemic-related orders—factors expected to normalize in 2022.
Inflation and Monetary Policies in Major Economies
The eurozone has exited recession, and GDP growth is expected to be around 2%. At this stage, there is no justification for an imminent interest rate hike, as the European Central Bank (ECB) remains committed to liquidity injections, and inflation is expected to return below 2%.
However, in the UK, accelerated industrial production growth, labor market pressures, and inflation set to exceed 4% have led analysts to anticipate a Bank of England rate hike.
In Canada, strong consumer demand, supply chain disruptions, product shortages, and rising oil prices are driving inflation higher. However, the Bank of Canada remains firm in its stance, viewing this inflationary surge as transitory—an outlook shared by the ECB.
The United States is not expected to raise interest rates before late 2022. The relative weakness of the U.S. dollar is likely to persist, particularly against commodity-driven currencies. Meanwhile, with the European Union signaling that it will maintain interest rates at current levels until 2025, businesses should expect a strong British pound and a relatively weaker euro.
Inflation is also rising in emerging markets, where central banks must act decisively to prevent it from spiraling out of control. However, some commodity-rich nations, such as Russia, with its gas and oil reserves, may see their currencies appreciate.
Supply Chain and Labor Challenges
There is a significant caveat to these expectations. A series of economic challenges is creating strong hesitation in foreign exchange markets, even as interest rate differentials evolve. There are chronic shortages of raw materials and components across industries, along with significant order backlogs worldwide.
Overall, the macroeconomic landscape is characterized by deep supply shortages, coupled with central banks injecting liquidity into economies for years. This excess liquidity, combined with limited product availability, inevitably pushes prices higher. Additionally, labor shortages are driving wages up. When these increases become too significant, businesses pass higher costs on to consumers—another factor fueling inflation.
The Impact of the Pandemic and Variants like Omicron
A key question now arises: how will inflation impact currencies? The way central banks manage inflation adds another layer of uncertainty, as the world is only beginning to recover from the pandemic’s economic impact. This situation continues to evolve, as evidenced by the emergence of the South African variant. Market operators remain concerned.
The ECB does not foresee tightening its monetary policy, whereas the Bank of England and the U.S. Federal Reserve signal the opposite. The Bank of Canada is closely observing the transition to a post-pandemic economy. It does not view supply chain disruptions and their inflationary impact as a reason to tighten monetary policy.
Meanwhile, China’s central bank (PBOC), dealing with the Evergrande crisis and growing concerns over a credit and energy crisis (coal and natural gas shortages), must take further measures and inject increasing amounts of liquidity. While inflation in China remains low for now, upward risks persist.
Central Bank Reactions to Economic Uncertainty, Volatility and Inflation
Despite weaknesses in some sectors, the global recovery has taken a V-shape. However, volatile commodity prices, uncertainty surrounding central banks’ monetary policies amid fluctuating inflation, and the resulting currency market volatility are raising concerns. Businesses must reacquaint themselves with trading in an inflationary environment—something largely absent from economic discussions for over 20 years.
New trade restrictions due to a resurgence of COVID-19, another unexpected energy price spike, or prolonged labor shortages could create significant challenges for economic growth and the currencies of the most affected countries, despite central bank actions—at least in the short term. The gradual withdrawal of quantitative easing and shifting interest rate differentials between countries will be critical to monitor, as central banks are expected to adopt diverging monetary policies.
Currency Risk Management Strategies for SMEs
Amid rising uncertainty, businesses must continuously track their hedging strategies to ensure they remain effective. As such, building a currency risk management strategy should be as straightforward as possible. Complexity slows processes, strains resources, and increases the likelihood of costly errors.
In this period of economic uncertainty, businesses must remain vigilant regarding interest rate and currency fluctuations. Market movements can have significant impacts on international operations. For a more detailed perspective on current trends and forecasts, see Canada's International Trade Outlook published by Global Affairs Canada.
For further insights, explore these articles: Volatility and Inflation: Impact on Financial Markets and Volatility and Inflation: Impacts on the Global Economy in 2024
International Markets: A World of Opportunities
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