Squaring the Circle

The Economist September 7,2013 The world’s financial markets have been marked by contradictions throughout 2013.Inflation has dropped but government bonds have suffered.Risk appetites have revived but emerging markets have underperformed.Perhaps such anomalies are inevitable given the influence of

The world＇s financial markets have been marked by contradictions through out 2013. Inflation has dropped but gov ernment bonds have suffered. Risk ap petites have revived but emerging mar kets have underperformed. Perhaps such anomalies are in evitable given the influence of central banks on market sentiment. Offered a choice of knowing in advance the growth and inflation numbers for 2014, or the precise details of Federal Reserve asset purchases next year, investors would probably opt for the latter. If fundamen tals are not driving the markets, then fit ting price movements into a coherent e conomic framework is inevitably harder. More recent developments have at least had a familiar ring, as markets were once again affected by the curse of Au gust. In the first half of last month, bonds suffered as yields rose sharply. In the second half, equities were hit by the prospect of Western military intervention in Syria. Fear of conflict in the Middle East has been a regular source of market worry over the past ten years, although the worst nightmarea great disruption ofoil supplieshas yet to be realised. It is possible to explain some of the markets＇ oddities. The divergence be tween the performance of developed and emerging markets has reflected trends in economic data. America＇ s economy seems to be strengthening and Europe is edging out of recession even as the num bers from the BRIC countries （Brazil,Russia, India and China） disappoint. In 2008 and 2009 the question was whether emerging markets could decou ple from the crisis in the developed world. Now the problem has reversed it self. The developing world has a much bigger impact on the global economy than it did during the storms of the late 1990s. Although it is optimistic about America, Morgan Stanley has revised down its forecasts for global growth this year from 3.1% to 2.9%, and from 3.9% to 3.5% in 2014. Albert Edwards, a permanently bearish strategist at Societe Generale, sees the recent turbulence in emerging markets as ＂leading to a renewed global recession, with waves of deflation flow ing to the West from Asia as China is ul timately forced to devalue in the face of an unrelenting loss of competitiveness, most especially against its emerg ingmarket rivals.＂ But an emergingmarket slowdown is not all bad news. The Economist＇s allitems commodities index is 14.5% lower over the past 12 months, a devel opment that is broadly positive for con sumers in rich countries. The oil price is admittedly still well over S100 a barrel, in part because of Middle East tensions. But weak commodity prices are leading to lower headline inflation rates, giving central banks in the rich world plenty of scope to continue with their supportive monetary policies.