14 Leaders TheEconomistMay28th 2022
barren and almost uninhabited land. A decade laterIssaiasat
tacked tiny Djibouti to control the side of a disputedhill.Hewas
also accused of arming alShabab, a militia in Somaliaaffiliated
with alQaeda. These latter two actions provokedtheunSecur
ity Council to impose an arms embargo on Eritreain 2009 andfi
nancial sanctions on its political and military leaders.
In the past decade Eritrea has released Djiboutianprisoners
of war, signed a peace deal with Ethiopia andappearedtobe
mending relations in the region. As a reward theunliftedsanc
tions in 2018. Yet Issaias’s good behaviour did notoutlivethe
sanctions. He is widely blamed for having egged onAbiyAhmed,
Ethiopia’s prime minister, to wage war on the TigrayanPeople’s
Liberation Front (tplf), an Ethiopian partycumrebelgroup
that Issaias has resented for decades. Eritrea is againthoughtto
be supporting proxy forces in the region and itisbuildingup
forces on the borders of Tigray, where they threatentowreck
peacetalksbetweenEthiopiaandthetplf. “Everyoneisbegin
ningtoarriveatthesameconclusion:thatif thereisonespoiler
intheregion,it isEritrea,”saysa diplomat.
StoppingIssaias’smischiefmakingwillrequirefirmaction.
Americahasalreadyimposedfinancialsanctionsonhisarmy
andrulingparty. Theunshouldfollowthisleadandreimpose
anarmsembargoonhisregime.Thiswouldmakeitharderfor
himtothreatenhisneighboursdirectly,ortoarmproxies.Yet
thisalonemaynotbeenough.Regionalpowersshouldapply
pressure.TheUnitedArabEmiratesandSaudiArabiahavelong
givenEritreamoneyandfuelinexchangeforinfluenceandmil
itarybases.Theyhaveaninterestinstability;theyshouldmake
thiscleartotheirbelligerentclient.Finally,theregionshould
planforthedaywhenIssaias,whohasallowednopotentialsuc
cessortoemerge,diesoristoppled.Unliketyrants,contingency
planscanimprovewithtime.n
S
o choppy hasAmerica’sstockmarketbeenthisyearthatonly
a fool would predict midweek (or even midFriday)whether
prices will end the week up or down. At the market’scloseon
May 25th, the s&p500 index of leading Americanshareslooked
on course to break a sevenweek losing streak—ortoextendthe
rout to eight weeks. Thus far, at least, it has avoided(just)the
20% peaktotrough decline that is the informaldefinitionofa
bear market. But there are signs that America’s marketsareen
tering a new, more worrying phase.
From January until early May, falling share pricescouldbe
put down to the effect of rising bond yields, asfixedincome
markets responded to guidance from the Federal Reservethatin
terest rates would be going up a lot and fast. Higherinterestrates
reduce the present value of a stream of future companyprofits.
Shares were marked down accordingly, espe
cially those of technology firms whose profits
could be projected furthest into the future. But
in recent weeks share prices have kept falling,
even as bond yields have dropped back. This
combination points to fears of recession. In
deed, the mix of Fed tightening, slowing gdp
and rising production costs has the ominous
feel of the later stages of a business cycle. The
expansion is barely two years old. Yet investors are already wor
ried that corporate profits are under threat.
The world economy has been sideswiped by several big
shocks. China’s gdpis likely to contract sharply in the current
quarter, because of renewed lockdowns. Europe’s consumers are
suffering a squeeze on purchasing power because of skyhigh
gas prices. America’s economy had seemed resilient. But parts of
the economy that are sensitive to rising interest rates are falter
ing, even though the Fed has barely got going. Figures released
on May 24th showed that new home sales fell by almost 17% be
tween March and April. Any sign from corporate reporting that
demand is flagging is seized upon. When Snap, the company be
hind Snapchat, a socialmedia app, said this week that its sales
would be weaker than it had suggested as recently as April, its
sharepriceplungedby43%.ThesharepricesofWalmartand
Targetfellwhenthetworetailersreportedtheyhadbeenleft
withpilesofunsoldstockaftermisjudgingconsumerdemand.
Slowergrowthisoneelementofa textbookprofitsqueeze.A
consequenceofthemostlystablecostbaseofbigbusinessesis
that,whensalesriseorfall,profitsriseandfallbya lotmore.
Thiseffectboostedprofitsconsiderablylastyear,butasgdp
slowsitgoesintoreverse.Theotherelementofa profitsqueeze
ishighercosts.A varietyofbottleneckshavepushedupthepric
esofkeyinputs,notablyenergy.Debtservicecostsarerising
withinterestrates.Butthemainworryiswages.Thejobsmarket
inAmericaistight.Payriseshavebecomemoregenerousasa
consequence.CorporateAmericafindsitselfina doublebindin
thisregard.Ifitpassesonrisingwagecostsinhigherprices,it
willkeepinflationhighandforcetheFedto
raiseinterestratesmoreaggressively.Ifitab
sorbsrisingcosts,thatwillcrushprofits.
Is anyrelief for investors in sight? Some
soothsayers feel they are due a bearmarket
bounce.Theirtheoryisthatifa lotoftraders
havealreadysoldstocks,therewillbefewerpo
tentialsellerstodrivepricesdowninthefuture.
But a rally based on more balanced position
taking will not do much to change an awkward macroeconomic
backdrop for equities.
If consolation can be found in the present conjuncture it lies
in the fact that financial markets have done a lot of the Fed’s hea
vy lifting for it. Since the start of the year, bond yields have risen
sharply; mortgage rates have surged; spreads on corporate
bonds have widened; the dollar has climbed; and share prices
have slumped. In a counterfactual world in which financial
markets had shrugged off the Fed’s two interestrate increases so
far, the risks of a hard landing for the economy would, paradox
ically, be greater. Inflation pressures would keep building. But as
things stand, interest rates may not have to go quite as high as
they otherwise might have. Amid all the down days forthestock
market, this is not a great comfort. But every little helps.n
Why investors areincreasinglyworriedaboutrecessioninAmerica
S&P 500
January 3rd 2022=
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Prophets and profits
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