Avoid standing naked when the tide goes out

THE years 2020 and 2021 have been extraordinary. Ravaged by an unprecedented pandemic, major economies pumped in massive liquidity into their respective financial systems to save themselves from deeper stagnation. However, liquidity shots into the arms of industry and consumers for far too long can, and have, created the unintended consequences of inflation. Prices spiralled up across financial assets, wages, consumer goods, commodities, precious metals, cryptocurrencies, real estate and more. The Ukraine crisis has added fuel to the fire, with energy and grain prices soaring to new highs.

These inflationary challenges need to be tackled in 2022 by policymakers and central bankers. Economists in recent weeks are debating the number of times the US Federal Reserve must hike rates. I think the more meaningful debate should be around the appropriate real bond yield that would entice investors to the US Treasury market, and the time left for the US Fed to act decisively before it is too late.

Before the global financial crisis of 2008-9, US 10-year Treasury bonds rewarded investors with a 2 per cent real return. Today, with inflation running as high as 7 per cent, these investors are punished with a negative 5 per cent real return. Comparatively, China's real rate is hovering at around 2 per cent. While some central banks have hiked rates in recent months, Fed chair Jerome Powell has chosen to stay doggedly behind the curve, despite ample evidence of rising inflation. Is he in a bind now? Will he have to pull off a Houdini act to keep the economy humming, and to save financial markets from meltdowns?