The Twitter affair may signal the point when the “everything bubble” bursts

There is always a deal that symbolizes the end of an era. In the early 2000s, AOL’s merger with Time Warner signaled that the dot-com boom was over. Royal Bank of Scotland’s overpriced takeover of ABN Amro was followed by the global financial crisis of 2008-09. The question now is whether Elon Musk’s purchase of Twitter will be seen as the moment the global economy tipped into recession.

The signs are not promising. Even before Musk sealed the deal, tech stocks had seen a sharp selloff. The stock market value of Meta, the parent company of Facebook, fell by $80 billion on Thursday after Mark Zuckerberg’s company reported a 50 percent drop in third-quarter profit. The reason was simple: advertisers are reining in spending in response to slowing global growth.

Some repricing of tech stocks was inevitable as economies reopened after the Covid-19 pandemic. Facebook, Google owner Alphabet and Amazon were winners when consumers were holed up in their homes under lockdown and would always struggle to maintain such high levels of revenue growth as life returned to normal.

However, there was another reason tech stocks soared: the easy monetary policy pursued by the world’s central banks. Ultra-low interest rates and bond purchases through quantitative easing programs meant there was plenty of speculative money to go around.

What’s more, it wasn’t just tech stocks that were booming. The conditions were ideal for an “everything bubble” where stocks, bonds and real estate prices soared. In recent months, it has become clear that the “everything bubble” is over, punctuated by central banks tightening policy in response to higher inflation.

So far, it has really only been stocks and bonds that have fallen. However, there is evidence that higher interest rates are beginning to have an impact on the wider economy. The unwinding of the asset price boom is about to enter a new and far more dangerous phase as central banks test their economies’ ability to withstand higher borrowing costs.

There is a fear that the global economy is approaching the breaking point. China’s property meltdown, the Bank of England’s emergency measures to prevent pension funds from defaulting and the collapse of tech stocks are all part of the same story: a fragile global financial ecosystem coming under stress.

Dhaval Joshi, of BCA research, says 2022 was the year central banks’ “monster tightening” killed bond and stock market valuations, and 2023 will be the year this “monster tightening” finally reaches the economy and kills profits and jobs.

That may seem like a strange conclusion given that recent economic news hasn’t been all that bad. The US economy bounced back in the third quarter after six months of falling output, while Germany, France and Spain all expanded modestly. Unemployment remains low, with UK unemployment the lowest since 1974.

The good news won’t last, but while it does, it will likely encourage central banks to keep policy tighter for longer, so they can be sure they’ve squeezed inflation out of the system.

They won’t say much but they are prepared to see dole queues lengthened to reduce upward pressure on wages. Higher unemployment will not be a coincidence.

A certain inflationary pressure has weakened. The prices of oil and industrial metals have fallen far from their peak levels. Wholesale prices for gas were at 350 euros per megawatt hour in the summer but last week were below 100 euros per MWh. Durable goods prices have fallen as global supply bottlenecks have eased and demand has softened.

These price movements point to a marked weakening of global activity in the coming months. But central banks won’t be satisfied until they see wage inflation fall as well. That’s why the European Central Bank raised interest rates by 0.75 percentage points last week and why the Bank of England is expected to raise UK borrowing costs by a similar amount when its monetary policy committee announces its latest decision on Thursday.

Threadneedle Street will make its decision without seeing the full details of Jeremy Hunt’s Autumn Statement due on November 17, but will know the chancellor plans to raise taxes and cut spending. If the rumors are true, Hunt could siphon as much as £40bn out of the economy.

It is clear that this is a critical moment for the bank. The UK economy likely shrank by 0.5% in the third quarter; wage increases fail to keep pace with prices; business failures are increasing; consumer confidence is weak; activity in the housing market decreases; and global commodity prices are falling.

Against this, annual inflation is over 10% and core inflation – the cost of living excluding food, fuel, tobacco and alcohol – is over 6%. Official rates are now 2.25% and at the height of the panic after Kwasi Kwarteng’s mini-budget financial markets thought they could climb above 6% next year. The expected peak has since fallen but is still believed to be around 5%.

The bank faces the difficulty of not knowing when it will stop, but what is certain is that the peak in interest rates assumed by the financial markets is incompatible with a soft landing for the economy. Monetary policy operates with a lag, so the effect of raising interest rates now will only be felt next year, when inflation will fall and unemployment will rise.

Indeed, the Bank of England has probably already done enough to bring inflation back to its 2% target in 18 months to two years. Interest rates don’t have to go to 5% and if they do the bank will be guilty of massive overreach.

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