Financial Markets
It is a big mistake to think that rate cuts or lower bond yields will ease credit conditions. Quite the contrary. After an aggressive tightening of monetary policy, the first rate cuts always coincide with much tighter credit conditions. We discuss the implications for credit, government bonds and equities. Plus, we find a startling anomaly in equity sector performance.
It is too early to know whether the drop in bond yields will offset the drag on growth from tighter lending standards. But if it does, the net effect on equity valuations could be positive. This is enough to justify a modest tactical overweight to equities, with the proviso that investors should look to reduce equity exposure later this year in advance of a mild recession in 2024.
The Fed lifted rates 25 bps yesterday while also signaling that the tightening cycle is near its peak. We discuss the short-run and long-run implications for Treasury yields.
US financial instability reinforces our bearish investment outlook by weighing on economic growth and corporate earnings while also increasing US policy uncertainty and geopolitical risk.
Have global equity markets reached a riot point? Is the Fed going on hold a sufficient condition for stocks to stage a cyclical rally? If not, what would be needed to produce such a rally? Does the Fed’s recent balance sheet expansion foreshadow a rise in the US money supply? This report provides answers to all these questions.
The turmoil in US regional banks will weigh on economic growth. Arguably, it would be better for the broader stock market if growth slowed because banks became more conservative in their lending than if it slowed because the Fed had to raise rates to over 6%. In both cases, economic growth would decelerate but at least in the former scenario, the discount rate applied to earnings would not be as high.
The odds of achieving a goldilocks scenario in the US where inflation drops amidst robust growth are low. If US bank woes do not escalate, the Fed will continue hiking amid a contraction in US corporate profits and global trade. The recovery in China’s industrial economy will disappoint. Commodity prices are breaking down.
Bank failures are another ‘canary in the coal mine’ warning that a US recession is imminent, yet stocks, bonds, and the oil price are still a long way from fully pricing it.
Investors in Europe and the American West are already starting to think about the implications of the 2024 election, given that sticky inflation and tighter monetary policy keep the risk of recession elevated.
The first legislative meeting of Xi Jinping’s third term suggests that Chinese policy is continuous and consistent with the previous ten years, which is negative for long-term productivity.