There has been somewhat of a reversal of fortunes in the last few weeks. Whilst ‘higher for longer’ remains a theme, central bankers far and wide are starting to talk more about wages and their impact on policy. For some, Christmas has come early in the form of an inversion in the yield curve with cuts coming and sooner than previously thought. As a reformed rates trader, with the potential for a soft landing delivered by way of easing as economies cool rather than crash, what looked like it could go spectacularly wrong appears to be under control. For now at least. Too soon for Christmas cheer? Perhaps. Let’s hope the only hangovers are from joyful celebrations rather than market exuberance. Helpfully oil remains at around a five month low. Energy crisis averted.
To put this into context, the month of November was quite the outperformer. It is not since the autumn of ’69 that we have seen such returns. Global indices, along with the US and EM, once stripped out, gave investors approximately 10% on top of year to date gains. Europe ex-UK pushed 11% with the laggard Blighty at just over 6%. Fueled not just by the projected path of interest rates, with more easing predicted to come sooner, earnings have not fallen off a cliff. Helpful has thus far also been the relative containment of a property market crash in China, despite a sizable debt burden and “restructuring” that continues. Globally it does feel as though commercial real estate is due for a correction. The question remains whether rate cuts come soon enough to reduce the pain of the repricing of leverage.
This takes us nicely to credit, or the cost for non-financial institutions to borrow and their likelihood of default. Qualitative easing continues, the unwind real. Central banks are adamant that balance sheet reduction is the way to “normal”. Naturally this has led to a higher cost to service debt with recession still potentially looming of course. Strangely the risk of lending to corporates is not what one might expect, or at least not straightforward. With investment grade lending, the additional spread achieved right now is the narrowest it has been over the last 12 months. To get to where we are today, you have to rewind to 2013 to find a year where the average is above where we are looking to round 2023 up. Back to normal? The jury is out…
It’s a mixed bag for Europe. The Netherlands, one of the last bastions of the coveted AAA status, actually experienced deflation for the month of November according to Tuesday morning’s print. For the second month in a row. At -1.50% households should be feeling better off coming into Christmas. For the year, it also looks rather “normal” at 1.40%. The German wholesale price index, another potential leading indicator, also came in negative, potentially feeding into lower prices for goods on shelves. We will know whether the translation mechanism is fully functional as earnings come off for new and possibly more aggressive pricing strategies to feed through. With a policy meeting and announcement on Thursday, what had only a few months ago been certainty of hike has now melted away and in fact, at the time of writing, shows a tiny chance of a cut. For now, in terms of an actual change, it is timed with excessive eggs, chocolate and bunny-related merchandising. From a rates perspective, we may not see another resurrection. If you think we are at the top, adding term might help lock in higher rates for longer. As always, certainly not advice. The author remains skeptical of markedly cheaper money any time soon. The weakness in the powerhouse of Europe, Germany, has not gone unnoticed though and does pose a threat to overall growth/decline on the continent. GDP for the final quarter of 2023 is expected to come in at -0.10%. The 2% target for next year may well prove to be overconfident. Or require stimulus. Nobody wants inflation ticking back up though!
The UK’s November budget (or Autumn Statement) was a non-event. Coming into what may be an election year and a Conservative government with a slice of traditional folk that like to tax less, whilst the books looked in part better than expected, Santa was not present. In real terms, the likelihood is that many have been inflated into higher tax brackets along with the cost of our usual basket of goods continuing to rise at levels that are well beyond target. Halving to 4.6% was hailed as a victory, several battles won for sure but the war is far from over. Hard to sell the cooler than expected wage inflation given what has just been said. However, this does make the BoE’s job easier and improves the odds of rates coming in lower by June, from August, at least judging by investor sentiment and pricing of the risk-free rate. Again, no change is expected at Thursday’s meeting. The bet here would be an indication that we are not out of the inflation woods just yet…
Now over to the States. Jobs are holding up, wage negotiations and union action broadly in the rearview mirror. Projected rises from a survey run by Mercer is that employers are budgeting for a 3.5% increase in wages. Certainly well off the increases of Christmas’ past and present. In terms of liquidity in markets, it remained strained. With the Federal Reserve overnight facility actually being used to lend cash versus collateral, although not in significant size to date, this does expose potential cracks. It does make sense as QE continues to run off and issuance is whopping. The size of the US government debt burden increased around $1 trillion since the latter part of 2022, whilst demand has remained flat. This has broader implications in terms of cost not just for the government but the remainder of the financial system as governments seek to increase funds raised and need to move prices in order to attract demand. Sadly for the rest of the world this does imply spreads will again widen and the chase for liquidity enters the next stage. Debt ceiling uncertainty is likely part of the Christmas future as well.
To all our clients, partners and friends all that remains to be said is we at TreasurySpring wish you a happy, healthy and restorative vacation.