Pandemic era stimulus, low rates and easy money cannot go on forever. What remains unclear is how we get out of this without getting hurt. It seems inevitable that there will be some pain, the question is…. can recession be averted?
It is clear looking far and wide that valuations have been hit. Whilst technology has made the headlines, particularly some of the more recent IPOs at what now looks like the top of the market, more concerning has been the performance of companies dependant on the consumer.
(CNBC as of 17.05.22)
The trouble is, we are at very much the beginning of the tightening cycle and in some instances, there is still only talk as opposed to action, yet the destruction in value has been, to be frank, gigantic. Bear territory, where losses exceed 20%, looks to be coming for everybody. Below performance of the major indices in both local currency and rebased to USD.
(Bloomberg LLP, 24.05.2022)
Where there is mostly consensus…. the potential outcomes. At best a soft landing where inflation is tamed without forcing a recession, at worst high inflation and no to negative growth (stagflation) and alternatively a deflationary recession where goods and services cheapen whilst the economy shrinks.
For those that missed it, we have also seen the first (technical) default by a Sovereign in the Asian region for many years as Fitch rerated Sri Lanka down following non-payment of coupons beyond the 30 day cure period that expired late last week. More regular readers would rightly conclude that to me this might just be the beginning of things to come.
The ECB has no doubt been seeing other central bankers pulled over the coals for not moving quickly enough to avoid price rises going from high to unbearable. Just yesterday morning Christine Lagarde (ECB President) gave the clearest message yet that not only are rates set to rise, but twice, in both July and September. Finally, at least in nominal terms, you should get at least as much cash back as you deposited! With inflation in some parts of the Eurozone exceeding 10%, real rates unfortunately remain deeply negative.
As one can see from the below curve, despite conflict in Ukraine, since the beginning of February rate expectations for the 1 year risk free rate (proxy of 1 year OIS, ESTR) have shifted almost 0.75%, mapped here against current -0.50%. Worth noting is that other measures are less conservative indicating the pace of hikes might be steeper and sooner.
(Bloomberg LLP, 24.05.2022)
The big news in Sterling continues to be inflation, and more specifically the squeeze on household incomes, disposable or otherwise. With recent weakening in the pound and as a net importer of goods, the UK has been looking a little more “blighty” than usual. The Central Bank has faced yet more scrutiny of late with Governor Bailey being put very much on the spot following his prediction of recession and an eye-wateringly high +10% CPI print slated for later in the year. Polite reminder…the target is 2.00%. Following the last MPC we did see expectations for hikes curtailed, but as always time marches on, and so has inflation. The market now predicts rates to potentially exceed 2.00% by the end of the year. Some good news now. We have seen the pound strengthen in the early part of this week, helping at least stave off some price rises of the imported variety.
Federal Reserve Chair Jerome Powell, or “J Pow” as he has (entertainingly) been rebranded by some, does not have the (interest rate) moves. Twerks aside, the pace and magnitude of dealing with inflation late, and now playing catch up, did not go unnoticed by the powers that be. For the next several meetings a full 0.50% is a given and all communication has been that 0.75% moves are not off the table. This is just one metric that needs “normalising”. Getting there though, is another matter. When considering the size of the Fed’s balance sheet as a percentage of GDP, and mapping against base rates, then thinking about where stock markets have gone since the inflation-fighting endeavours of the central bank, it feels like getting back to flat is basically impossible. Further guidance to follow later this week in the form of the minutes of the last policy rate meetings which has the potential to move markets that appear to be more sensitive than “usual”.
(Fed balance sheet, % GDP [yellow], NASDAQ [green}, base – upper bound [white], Bloomberg LLP, 23.05.22)
There is good news though. Cash is back. Rates now mean something. Companies far and wide can benefit from our market-leading levels that move with both the times and expected future path of interest rates.