Indeed, given that the current context features a record overshoot of inflation vs. Current 10-year real rates remain 30 basis points below the 2018 level of 1.2%, which doesn’t seem to be the right policy calibration, as core inflation is at a 6.0%. Nevertheless, history also shows that the Fed never stops to tighten financial conditions before 10-year real rates rise above 1% (4.2% in 2000, 2.5% in 2007 and 1.2% in 2018). Over the last three Fed-hiking cycles since 1999, the change in 10-year real rates was on average 110 basis points, hence a bit lower than the current adjustment. Since the first Fed rate hike in March 2022, US real 10-year rates have risen by roughly 130 bps from -0.7% to 0.6%. We believe that real rates, which reflect the difference between nominal rates and inflation expectations for a given maturity, are good tools for determining the nature of monetary policy. Reverse Goldilocks means higher real rates… As a result, “Don’t Fight the Fed” would imply higher real rates and tighter financial conditions, which is historically a less favourable context for growth-oriented assets, especially after years of “beta party”, fuelled by an ultra-accommodative policy mix. The bad news is that the required tightening in financial conditions to curb inflation could be larger than currently priced, which in turn would increase recession risk and lower the growth premium in the coming months. As such, our US Growth Nowcaster is far from recessionary levels. The good news is that current expectations for monetary policy and earnings growth incorporate a lot of bad news, including a hawkish Fed, weaker macro momentum, and higher uncertainty. We continue to believe that the interplay between real rates, gauged through market based inflation expectations, and the scale of the US economy slowdown, which we track via our proprietary Nowcasters, will provide the best signal to differentiate between a bottom in equities and bear market rally. We prefer staying cautiously positive, mainly because we think that the tightening of global financial conditions is far from over. Most bullish investors base their views on the following elements: 1) bearish sentiment, 2) no recession, given the strength of US consumers, 3) global post-COVID reopening, and 4) China stimulus and recovery. ![]() ![]() Given the repricing which occurred in the first months of the year, the key question for the coming quarters is: “Where will this journey end?”. Against this backdrop, flexibility in views and positioning are key to navigate a world where any incremental change could dramatically affect market sentiment.
0 Comments
Leave a Reply. |