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It is almost inevitable that a sort of hysteresis forms a very large part of how financial markets form their expectations of today’s price movements. Traders and analysts are always looking out for how economies and markets behaved in the past when we see events repeated in real time.

For instance, what did central banks do the last time inflation was this high? Does the US debt-ceiling crisis of 2011 teach us anything about today’s crisis? And does the 2008 global financial crisis provide a pathway to explain how policymakers and markets might react now that bank tensions have flared again in the US? This desire for what psychologists’ call “anchoring” is understandable because it is clearly much easier to think about an issue when there’s a historical template available then when we are flying blind. Of course, some things happen where there’s very little historical precedent, like Covid-19, but others seem to happen with sufficient frequency that they are assumed to provide a reliable guide when they happen again.

However, it is always wise to see history as a good guide to the past; not necessarily to the future. Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said the surge in inflation and policymakers’ response to it is just one such example. We say this because it seems to us that markets are treating current events like past bouts of inflation; when the rise in prices was relatively modest and driven largely by the perception that demand in the economy was too high. Today’s inflation is not modest and nor has it been driven by a surge in demand. Of course, demand did bounce back after pandemic lockdowns were eased but this was temporary and takes nothing away from the fact that the inflation problem was (and still is) a problem of insufficient supply, not rampant demand.

We first saw the insufficient supply problem in the goods market with supply-chain problems, and now the problem of insufficient supply has transferred to the services sector because labour supply is insufficient. These supply strains don’t preclude a fall in inflation and, indeed, in many countries we have already started to see this. But whether this will end up with inflation back at central bank target levels on a sustainable basis is another question. What the market seems to be saying is that this inflation and monetary policy cycle will be like previous ones with banks able to cut rates not long after they have reached a peak.

In the US, for instance, the market is just about priced for the first rate cut in September. That’s just four months after the last rate hike (assuming the hike in May was the last). Hysteresis might suggest that the Fed moves pretty quickly from tightening to easing and that’s what the market is pricing in again right now. For others, like the ECB and BoE, it might take a little longer for the peak to be hit and the first cut to occur but, here too, the market is assuming quite a quick turnaround, to mimic the policy volte-face being priced into the US curve.

“Our point, and perhaps that of the Fed and others is that it is likely to be different this time. For instance, if the rate hikes to date slow demand, and possibly even cause a recession, will this lead to the same sort of deflation that we might have seen in the past, given that today’s inflation problems are supply driven, not demand driven? In fact, we can take it further and say that if weak growth adversely impacts supply potential, by hitting investment, for instance, the end result could be very uncomfortable stagflation which would leave the central banks – and the markets – in a terrible bind. We do still see rates coming down in time but market impatience may not be rewarded and could even lead to significant losses for those investors that are too reliant on the past in dictating today’s asset choices”, said Mr. Steve Barrow.