"The stakes are very high. Political leaderships have a low tolerance for a deep recession. Unless the Fed’s aggressive strategy bears visible fruit within the next few months, the US central bank could be blamed for crashing the fragile post-pandemic global economy.”
Cleveland says the above says the above approach risks central banks lifting rates by more than the respective economies can tolerate, which would likely lead to inflation.
The latter approach would potentially mean allowing inflation to remain higher for longer, a scenario which could also lead to recession.
But Cleveland doesn’t believe the strong dollar will have a negative impact on the US economy. He said: “It can help keep the costs of US imports low. Though where it could hurt investors is, the value of overseas earnings of US companies could be lower.”
He adds that if the global economy does weaken, and enter a recession, the tendency is for dollar assets to become a safe haven. That means even if central banks outside the US did intervene to keep their currencies relatively strong against the dollar, if those actions led to a recession outside the US, it would result in the dollar strengthening anyway.
Anthony Rayner, multi-asset investor at Premier Miton, said markets continue to predict peak inflation, “and keep getting it wrong”, and as long as inflation continues to rise, the dollar is likely to strengthen, something which dampens the returns available from most asset classes as liquidity is reduced.
Reduced liquidity occurs because dollar strength makes the income from US government bonds relatively more attractive, causing US investors to bring the capital they had deployed over seas back home.
In terms of what the central banks dilemma means for investors, Thompson said: “The temptation at times of market turmoil is always to bail out. However, the indisputable lesson of history is that this is the wrong course of action for any investor with a medium to long-term horizon.
"Over the last 50 years, there have been numerous crises and sell-offs and yet equities have always managed to recover and produce long-term inflation-beating returns. Trying to time a market bottom is all but impossible and risks missing the best performing days in any rebound, which has proven very costly in the past.
"This is far from saying that we are taking no action on our client portfolios. But it is all about rebalancing, rather than wholesale de-risking. Bonds for instance are looking considerably more attractive now they are once again paying a respectable yield. As for equities, a considerable amount of bad news is priced in and sentiment fast approaching rock-bottom levels”
