Mohamed A. EI-Erian
FINANCIAL markets are generally seen as providing the best unbiased insights into future economic developments. But in recent months, many market segments have appeared to be sending competing, if not confusing, signals, such as the following:
• Many national equity markets finished 2006 at or near all-time highs, prompting analysts to see them as signaling confidence that robust global growth and subdued inflation will continue—what has become known as the “global Goldilocks” scenario (“not too hot, not too cold”). Yet bond markets—especially in the United States but also increasingly elsewhere—were suggesting a more cautious outlook.
• There has been an unusual degree of disagreement among major Wall Street analysts (the “Fed watchers”) as to the direction of U.S. policy rates in 2007. With the Fed Fund’s rate at 5¼ percent, some have predicted a move down to 4 percent by December of this year, others, a move up to 6 percent. Moreover, measures of market volatility have been unusually muted across virtually all major markets (including foreign exchange, equities, and fixed income) notwithstanding the lack of market conviction about U.S. policy rates.
It is tempting to dismiss these competing signals as “noise”—that is, market movements devoid of serious information content. But that would be inadvisable. These apparently inconsistent signals carry important information about the changing global circumstances facing national policymakers, multilateral institutions, and market participants—circumstances that call for changes in the way these participants in international finance react.