Equity markets around the globe continue to struggle as they adjust to higher bond yields. We were lucky enough to attend the Capital Economics Annual Conference in London on Tuesday. The headline topic. What will cause the next major Global downturn? Rather more than the 64-billion-dollar question. That then begs the question, if we knew the answer, would it be the cause of the next downturn? By definition, if you know an event is going to occur steps are usually taken to prevent it.
What could be the answer? I am not sure any conclusion was made as to what the answer might be. What is apparent is that a couple of things it’s unlikely to be, that the equity markets currently concern itself with, and the one it is most likely to be is the one it usually is. Higher monetary policy, but at which point do equity markets take fright? The ones we can apparently rule out as less likely to cause the major meltdown are Emerging Markets and trade wars. The number of Emerging Market crisis have been declining and external funding requirements have been falling over the past 20 years. Trade wars would have an impact if they escalated materially. A Chinese hard landing would knock global growth, which would, in turn, hit equity valuations. However, you would probably expect a policy response from central banks.
Tighter monetary policy driven by inflationary concerns at some point impacts growth and causes a recession. Higher oil prices almost always lead to a recession as it forces central banks hands and reduces real household income. A tax on the consumer.
One Capital Economics slide was labelled the “death of inflation” as central banks targeted inflation after the 70’s and 80’s when Consumer Prices rose as high as 18% in the G7 economy. A spike to anything close to those levels again would probably cause chaos today.
At what point do interest rates start to impact, in 2003 and 2007 two-year real US treasury yields rose to two pct then the recession hit. Currently, even after the recent rise, two-year yields are barely above zero. Some analyst reports suggest equities don’t really get affected until 10-year US yields hit 4.5-5%, currently, they are just above 3.2%.
There was some analysis on what we learn from history. This period will be analysed by many future economists. A lot of what has occurred since 2007 has never really been repeated before so maybe assuming what will cause the next downturn looking at history may not give us the clues we need. Time will tell, but it was fascinating to have the opportunity to be part of such a well-prepared debate.