Global equities were fussy at the beginning of a week that’ll presumably be defined by “jobs, jobs, jobs” in the US, and more hand-wringing over Europe’s existential energy crisis and China’s “slowdown” (don’t call it a recession).
The mainstream media narrative dutifully followed the price action. “Rally hopes crumble,” a Bloomberg headline lamented. The journalists employed a “we knew it all along” cadence. The rally, they said, “was just a blip in a bear market that’s likely to worsen from here.”
The linked article included words like “chaos” to describe losses of between 1% and 3% across global benchmarks. The media might be well advised to save some hyperbole for later — it could get considerably worse from here.
US shares re-rated to almost 18.5x over the course of the summer surge. Arguably, that’s an indefensible multiple under the circumstances. Two-year US yields hit the highest since 2007 (figure below) on Monday and although the dollar trimmed gains, the easy (you might even call it “lazy”) call is for an ever stronger greenback, especially considering the notion that recessions in the UK and Europe could prevent the Bank of England and the ECB from “matching” Fed hawkishness going forward. “Tightening pain equals dollar gain,” as Goldman’s Kamakshya Trivedi put it. The ECB got a late start anyway, and even if they opt for a 75bps move this month, that’d still put the depo rate at just 0.75%, and a hike that size could be the death knell for the bloc’s economy as the cost of living crisis snowballs into the winter months.
One complicating factor in rates is the difficulty of deciding what to trade. The energy spiral poses severe upside inflation risk in Europe and the associated policy response is ostensibly bearish for bonds, but the very same severe inflation and the very same policy response threaten to push economies into the deep abyss, which would presumably be bullish for bonds, unless you think the UK and Europe are literally turning into emerging markets.
“Since the early-August yield lows, European and UK fixed income has been a significant exporter of bearish impulses,” Goldman’s Praveen Korapaty said. “The combination of less negative than feared euro area growth news alongside intensifying energy-driven inflation concerns have supported the across-the-curve repricing in those markets, while US rates have broadly lagged the selloff,” the bank added, noting that “although foreign spillovers typically occur in term premia further out the curve, the common, inflation-focused nature of the policy cycle across markets has resulted in significant co-movement of front-end rates across most of G10.”
The read-through for equities seems unequivocally poor. The price action on Friday and into Monday plainly indicated stocks were hoping (against hope) that Powell would take a “balance of risks” approach in Jackson Hole, but he didn’t. Mostly because the risks aren’t balanced. Or if they are now, they weren’t previously, and the Fed everywhere and always drives while looking in the rearview mirror. Yes, inflation risks are still skewed to the upside, but growth risks are now skewed to the downside. The Fed is belatedly reacting to last year’s conjuncture, when both inflation and growth were biased higher and hotter.
So, “restrictive for longer” it is, and stocks aren’t excited about it. “Knowing rates will remain ‘higher for longer’ in a restrictive state for an indefinite period of time prompts investors to move to the sidelines until opportunities appear more attractive from a price or time perspective,” JonesTrading’s Mike O’Rourke remarked, adding that “investors are looking at a 2023 which will be comprised of slowing global economies and slowing corporate profits accompanied by global policy tightening and global quantitative tightening, not the type of backdrop that inspires investors to pay a multiple of 20x earnings.”
Meanwhile, Rabobank’s Michael Every offered a characteristically colorful postmortem of the Fed’s symposium. “So, to J-Hole and its title of ‘Reassessing constraints on the economy and policy’ — How apt!” he exclaimed. “What larger constraints on monetary policy are there than knowing that raising rates ruins the unproductive parts of the economy but doesn’t incentivize the productive parts we desperately need, and lowering rates only incentivizes socio-economic necrosis?”
