Well, actually, quite a bit. In less than a month, it feels like courses have been altered. Concerns around energy, inflation, employment, recession and the consumer seem to have melted into a bull market. Risk is back, baby. Along with the many job cuts in tech, it’s beginning to hit finance and beyond into the “real” economy; even Ford have announced headcount cuts running into the several thousands this week. Arguably some of this is off the back of stimulus-fuelled exuberance and inevitably will only go in one direction. For now though, there is talk in the US (and possibly beyond) of not just a “soft” landing but no landing at all. Even the bears of just a few months ago, such as J.P. Morgan, see reason to be cheerful.
Global indices as of 24.01.23, YTD far right. Courtesy of Bloomberg L.P.
Globally, inflation appears to be coming down whilst employment, despite the aforementioned, is holding up. Escalation of conflict thus far abated (although I’d rather set sights higher and for peace). Equities in general are back in fashion, despite the mixed picture YTD around both earnings and expectations. But why? Well in Europe and the UK, multiples remain considerably less lofty than across the pond. Even the IMF’s Number Two, Gita Gopinath, announced just last week in Davos that the global economy is showing “signs of resilience”.
China is now open to the max, with effects likely to be felt on both sides of the in/deflationary coin as supply chains ramp up, met with a resurgent consumer that has faced a rather elongated period of being “grounded”. The likely winner here, according to some experts and investors alike including Nicolai Tangen, head of Norway’s $1.3 trillion sovereign wealth fund, is…higher prices. True as this may be, we cannot rely on the Chinese consumer to bail out the likes of Apple, Tesla, Google, and the rest of the gang.
The reality is we are still all experiencing a squeeze on our incomes both real and disposable. This despite the best (albeit late) efforts of central banks. “Normalisation”, whatever that is (presumed by the author to be a world where we at least don’t have to pay what can feel like an additional £ per pint, week on week), is apparently coming very soon. Looking at rate markets, we are nearing hike-cycle highs and needing central banks to ease (i.e. cut benchmark rates) this year. According to PwC’s latest business leaders’ survey, 73% expect growth to decline globally. Recessions come and go, but more concerning is that 40% are worried their company may not survive the next decade. BlackRock Investment Institute strategists have put it rather succinctly, we are “vulnerable to negative surprises – and unprepared for recession”.
The Euro is a tough beast to tame. When times are good; most economies are experiencing positive growth, healthy employment and price stability. Rate-setting and forward guidance – no problem. Nothing to see here. Currently we are not there. Christine Lagarde, ECB President, highlighted the need for continued, and sizable rate hikes on Monday. The rhetoric is all around an environment that becomes restrictive enough to return inflation to target, and stay there as long as necessary. The problem she and other members face is one of divergence. The latest inflation print for Latvia (for December) came in at a chart topping 21.7%, joining the Euro on 1 January 2014, when “Timber”, courtesy of Pitbull and Ke$ha, was number 1 in the charts. Almost seems ironic now! On the other end of the scale, our Spanish friends have what could currently be considered an enviably low 6.7%. For the area as a whole, 9.2% is almost FIVE times higher than target. One may then think that rates are projected to rise for the rest of the year. Sadly though, it is not only Pitbull and Ke$ha that have peaked. Rates here are set to follow a similar trajectory if implied policy rates, as projected by markets currently, are anything to go by.
Euro rate expectation, based off future markets. Bloomberg L.P.
Then there is the relative debt pile of members, both outright and on a percentage of GDP basis. This is for another time though. A return of the Sovereign spread is likely to bring along its ugly cousin, credit spread. But then why should one not be paid a real premium for taking on more risk?! Particularly in a time when the global economy is clearly restructuring, and hastily so.
In the UK, whilst we are told inflation is due to slow with hikes continued to be pencilled in for the foreseeable future, are we in for a potential second round higher, leaving us more exposed than others? Much like elsewhere, the consumer appears to be showing signs of fatigue as both sentiment and sales are tracking lower. This comes before the full brunt of rate hikes kicks in for those with mortgages that are yet to reset higher. The Bank of England in its last projections sees inflation returning to a meagre 2.4% by the first quarter of 2024, from prints that remain in the double digits. I am all for optimism, but with the effects of Brexit and a strong labour market (now less flexible and seemingly at the mercy of unions), the inversion also feels like too much too soon. Below is one measure of market expectations as to the future path of rates to the end of the year.
The UK is feeling susceptible to prolonged stagflation if things do not improve. In other news, the Prudential Regulation Authority has shone a light on another pocket of the market that could lead to disorderly unwinds this week: life insurers. Whilst found to be robust, assumptions around the unwinding of positions in times of stress (and likely to be correlated, thus exaggerating moves) and current liquidity modelling requires work. Too much reliance has been placed on the timeframe to shift what could run into several £ billion and at prices that might be hard to achieve. Feels like we have not just heard, but actually seen this all before, and recently. There is some good news at least; gilts purchased to restore order in the LDI space have been successfully unwound. Let’s try and keep the sheet clean though?!
The States continues, in part at least, to defy gravity. Jobs look ok, inflation is certainly coming down, and whilst there are layoffs occurring thus far, it’s still holding together. No surprise then that the NASDAQ has been the best performer to date. Equities like to get in early on any whiff of a plateauing or cutting of rates. Whilst the FED remains firm on tackling prices, as well as telling us all that we will likely sit higher for longer, it seems fair to be sceptical – given prior promises of “transitory”. What feels recurring is another debt ceiling looming, which will be resolved. In the meantime though, the front end of the treasury bill and rate markets are likely to suffer, as government issuance (including treasury bills, sorry folks) declines at a faster pace than the rehoming of cash in the real economy. Inversion here is more extreme than anywhere else. I believe in the current rainbow-like curve there is about as much chance of finding a pot of gold at the end of one.
As we enter 2023 with newfound optimism, it is certainly worth keeping an eye on how central banks are going to deal with the reversal of quantitative easing. Reducing liquidity at a time when debt levels are at all-time highs from a background of ultra-cheap and arguably hugely mis-priced credit, along with rate hikes that are yet to happen (let alone feel the full force of those that have been before), we may well be in for a bit of a ride, and lots more acronyms. Perhaps the only way out is a rainbow.
Barbell or dumbbell? That is the question. It might be time to take advantage of higher term rates prudently in case they disappear whilst managing liquidity in shorter dates. Surely better than the latter of leaving cash on call, purchasing power forever and continuously eroded. Just make sure it is in the right homes…