To have or not to have?

Henry Adams

Chief Product Officer
Thursday, May, 16, 2024
3mins

If markets are to be believed, we are less than a month away from the first rate cut in Europe. One can argue either way: being needed, overdue, or that inflation will be persistent and thus fuel is only being added before putting the fire out. What is certainly clear is that we are decoupling from how some of the major economies have typically led or followed in previous economic cycles. This, along with divergence between the have and have-nots, is likely to add further fragmentation on both a macro and local level. 

Macro

Central bank policy of old, with banks cutting at similar times and, in percentage terms at least, magnitude, are not for this cycle. The Bank of Japan has finally left negative rates and finds itself forced to defend its currency whilst Europe and the UK are squarely set on providing monetary relief in the form of not just one but several cuts this year. Looking further west, the US, now with a several decades-high share of global GDP, at over 26%, appears to continue to power ahead despite what many see as restrictive policy. Rates here though, for now, do not look to be going anywhere. There has even been commentary suggesting the next move was up, a theme also discussed at their last central bank meeting. This is important to note, as there are broader currency and therefore inflation implications for likely divergence. On top of that, one must factor in net trade and think about whether a  stronger home/away unit of money is better or worse when considering the balance of payments. In short though, the global currency remains USD, and thus a higher for longer rates outlook and strengthening $US have far-reaching implications given their use not just in the exchange of commodities but as a peg and often source of outside funding for emerging economies. The squeeze is real and if prolonged will continue to challenge particularly those that have borrowed extensively are experiencing increased debt servicing costs through no direct fault of their own. But just cut, I hear you say! Well the trouble is, this would be a catalyst for increasing repayment obligations as the home currency weakens. We’ll likely see additional countries requiring renegotiation of terms to avoid being shut out of global markets and/or default.

Risk

Earnings season for the first quarter of 2024 is all but over. In short, roughly 80% of the S&P 500 has outperformed expectations. This is reflected in the US and other indices continuing to flirt around and through record highs. As always though there are reasons to be cautious. Employment data over the period has certainly cooled, along with inflation, and thus one must ask to what degree such exuberance is powered by expectation of cheaper money? Should central banks disappoint, we may well see a faster contraction than desired. 

Credit 

It’s been an interesting few months. First a bonanza of issuance facing what appeared to be an unlimited supply of money at levels that on a historical basis were about as tight as it gets. Little reward for considerable additional risk. In part, locking in higher is a wise move with that easing potentially coming down the pipes. In our last piece, following both Easter and a period of heightened geopolitical tension, from a liquidity standpoint at least, conditions appeared to be diametrically opposite. Thankfully fears have abated, as history tells us that periods of illiquidity, if not resolved, often result in periods of elevated insolvency. As of now, deals are being made far and wide, with the cost to borrow versus government levels (or simply put, the risk-free rate) off those lows of February and March. Worth keeping an eye on though, is that very same risk-free benchmark rate. As central banks have looked to reverse free and easy money, concerns are mounting that a new environment is taking shape; one in which liquidity is naturally being drained alongside the shrinking of central bank balance sheets. With additional regulation coming in and banks preparing accordingly, the price of money for all alongside increasing government issuance, can only go up. The good news? Unlike where we found ourselves with a decade of rates close to zero, we are armed and ready with cuts back in the toolbox for those rainy days to come. Even better? Cash is an asset that can support the bottom line. 

EUR

The philosophy of being increasingly data driven has not been lost on those steering policy. Non-committal has also been the name of the game. Transparency in the Eurozone at least though, appears to be back on the agenda. Bar any shocks and surprises, something the ECB is certain to want to avoid, a reduction in the benchmark interest rate of 0.25% on the 6th of June is done. Whilst unlikely to make much of a difference, and to be seen whether borrowers will actually see any benefit versus those long of funds, it does signal that there is both ability and appetite to ease and appease. The author certainly believes that an arbitrary target, in most cases of 2%, would be expensive to squeeze for in isolation. The fly in the ointment and a double-edged sword is that across the mighty euro-area, pay growth has not cooled to the extent the ECB would have liked. Real wage increases are generally something that should be celebrated. The backdrop though of diverging and cooling economies with, in many cases, meagre growth, has us at a juncture where stagflation may become the new normal. Nobody wants to see no growth and spiralling prices…

GBP

Sentiment is mixed, with even voting members appearing to contradict themselves from one sentence to the next. Hitting the headlines has also been talk of the independence of the Bank of England, again. Jeremy Hunt, our Chancellor, has publicly urged the BoE not to cut rates too quickly. Mortgage holders far and wide, along with those looking to step onto the ladder for the first time, will naturally be disappointed by such chatter. One point though is rightly made. Being early is the same as being wrong. That strengthening dollar is no good omen for an import-driven economy such as this, and so divergence in policy becomes a riskier business. A cut has at least in rhetoric been kept on the table for June 20, with the latest inflation figure remaining at 3.2%. The bank finds itself in probably the trickiest spot of the three majors when it comes to when, by how much, and how frequently to invigorate the economy without stoking a repeat of price escalation. Let’s not go into the basket of goods measured and how inflation figures are assembled, needless to say though there is some scepticism here which is immediately apparent when walking out of the door and being able to empty pockets ever more quickly. It was great to see an end of the technical recession at least with the bonus of growth exceeding expectation, according to last weeks’ data. 

USD 

A looming election brings new dimensions into the fold. Policies to capture different crowds are well underway. One of the most relevant and immediate of those is the announcement Tuesday by President Biden himself that China will now face far higher tariffs on a range of goods. Taking the top spot? Electric vehicles, where said taxes will rally from an already considerable 25% to 100%. You’ve got to really love that car to bite that bullet. Additionally, considerable increases are set to hit lithium batteries and semiconductors on the one hand, whilst inputs such as steel and aluminium are all facing a similar fate. The range across this basket of “goods” is between 25-50% higher. Whilst much of this is bark overbite given his predecessors work on tariffs, it is clear the US will make big calls to protect the economy in a fashion not seen for many a year. This has also taken the wind out of much of Trumps’ sails, where “everything Chinese” would be hit by a minimum of 60%. 

Domestically it is increasingly a tale of two halves. Or haves and have-nots. Increased borrowing via BNPL going unchecked along with diminishing savings for those not fortunate enough to be in a position to save, skewing the data and thus overall perceived health of households. The value of taking in such detail is more important the longer we remain higher for longer. Time will tell how this plays out but such dynamics are important to factor into one’s thinking when considering the strength of an economy. Only as strong as the weakest link? 

Wednesday saw a further drop in headline inflation for the month of April to 3.4% and in line with what the experts had predicted. Less great was the drop in manufacturing as well as retail sales figures which disappointed, coming in flat versus a prediction of growth. The result? Yields dropping and yet another record high for the S&P 500.

So what? 

With so much going on it is important to bring it back to some of the basics. Whilst restrictive monetary policy is coming to an end, the velocity depending on geography is differing, and in new and different ways. Whilst there is a degree of certainty, what is yet to be established is to what degree any easing might be early, late, or ideally, right on time. There remains a chance of soft landing far and wide, or in the case of the US no landing at all. Finding certainty in an uncertain world can be hard. Needless to say, in the wonderful world of cash management we remain happy and committed to be an all-weather bastion. 


*TreasurySpring’s blogs and commentaries are provided for general information purposes only, and do not constitute legal, investment or other advice.

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