The Fed, moving from a rock to a hard place ?

Let’s ignore Brexit except to continue to note the relative strength of sterling despite all the uncertainty. Speculators appear to be leaning to the idea that a soft solution will be found to current times. The increased possibility of a General Election this year that could see Labour, maybe not under the stewardship of Jeremy Corbyn, come to power, likewise does not seem to be undermining the currency.

Global bond markets rally, leading to a fall in yields, as analysts continue to see increased risks to the global economy, at the same time lowering inflation expectations. Yields on ten-year German bunds have fallen back below zero, and only time will tell the significance of this and the destiny of the euro in its present form. Sentiment has turned more cautious in all asset classes; as you see risk aversion, risk indicators are moving to fear. The yen has been rallying against the US dollar; gold has been well supported, oil slipped back, as we said bond yields have been falling. According to Credit Swiss research, the current term spread model of recession probabilities has been followed by a recession in five out of the last seven times, between the next six and twelve months. All may not be lost as a piece of JP Morgan’s research notes that the S&P 500 delivers above-average returns for 30 months after the inversion. Hedge funds have likewise become more cautious reducing net exposure to equity markets.

The Fed will apparently become net buyers of treasuries by October 2019. We now move into what may be an even riskier time for central banks. 2008 was clear, flood the market with liquidity, save the banking system and prevent a deep economic depression similar to the 1930’s. We did that, or rather they did that. The trade-off has been a boom in borrowing by corporates; the OECD pointed out that over four trillion dollars need to be repaid over the next three years. The reality is that a lot of this debt is likely to be refinanced. However, there has been a boom in corporate borrowing most of it used to retire equity, as debt has been cheaper than equity.

Should the Fed start to lower rates again, the market now prices an 80 pct chance of a cut this year. Corporate borrowing could rise even further. The Fed will continue to hope one day that the global economy will grow fast enough to reduce the debt burden. For now, the world’s central bankers will continue to clutch to that hope.

Posted on March 28, 2019 .