A developing consensus in the global stock market is that a recession in the US, the world’s largest economy, and by extension the global economy, is imminent.
A look at the US Treasury market shows that bond investors are pricing in lower interest rates in 2023, as they see a growing possibility of a recession on the back of the Federal Reserve’s aggressive interest rate hikes.
The Fed has already raised interest rates by about 150 basis points (bps) since March and is expected to go for another 150-200 bps hike by the end of the year to bring the policy rate close to its neutral rate of around 2.75-3.25 percent, at which monetary policy will neither be expansionary nor contractionary.
The market, however, thinks the Fed is wrong in its assumption.
The most immediate effect of this developing consensus has been felt in the global commodities market, which has seen an intense bout of selling over the past few weeks.
The Bloomberg Commodity index has fallen 14 percent from its highs in early June. Similarly, the US 10-year Treasury bond yield nosedived 59 basis points from a high of 3.47 percent in June to 2.88 percent last week. One basis point is one-hundredth of a percentage point.
Oil prices, an indication of the global economy's health, have fallen 15 percent since mid-June, while industrial metal copper is hurting at a 14-month low.
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Who is afraid of a recession
This suggests that a recession is imminent and yet look at equity markets. The S&P 500 index is up 7 percent since mid-June, technology-heavy Nasdaq Composite has gained 10 percent.
At home, the BSE Sensex secured its best weekly performance in three months in the week gone by and is up 6.5 percent from its 52-week low hit on June 12.
“Actually, I think that recession 'fears' should really be described as 'recession hopes',” said Anatole Kaletsky of Gavekal Research in a recent note.
Kaletsky’s argument has merit, given that an early US recession solves all the problems that have plagued equity investors recently—surging inflation and unplugging of the dopamine effect caused by ultra-low interest rates.
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The tantrum thrown by global stock, bond and cryptocurrency markets through the best part of the past eight months has been a reflex action to the high of record liquidity and low-interest rates being cut off, as central banks focus on the job they were hired to do–ensure price stability instead of managing asset prices.
The fact that Federal Reserve received $2.1 trillion in deposits in the reverse repo window on July 8 shows the extent of easy money still sloshing around in the US banking system that lenders have no use for. The surging reverse repo deposits are also an indication of the overzealousness of the central bank in protecting the economy from the COVID-19 pandemic.
A reverse repo window is one where banks deposit funds with the central bank at a fixed rate and tenure.
“This new market consensus is completely wrong, at least in my view. I believe there is almost no chance of a US recession this year or early in 2023,” Kaletsky asserted.
The US jobs market report on July 8 showed that the economy added higher-than-expected jobs in June despite all the noise around hiring slump and warnings of an economic “hurricane”. It suggests that investors need to get used to the fact that interest rates are likely to remain high for a long time.
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Mars is still some distance away
Investors adapting to a world where monetary policy easing has a direct bearing on inflation, unlike the years after the great financial crisis of 2008, and can no longer prop up asset prices, will be harsh and painful.
For the Indian investor, the readjustment of the global monetary policy regime means that foreign investors are nowhere closer to reversing their record-setting selloff than Elon Musk is to colonising Mars or buying Twitter.
Domestic investors must now contend with interventionist actions from the government in various sectors, which is mindful of not letting inflation get entrenched ahead of the 2024 Lok Sabha elections.
“The market outlook is pretty simple and straightforward – Moderate return expectations and focus on capital preservation,” said Amit Kumar Gupta, founder at Fintrekk Capital.
The logical approach for investors then is to remain vigilant and play the waiting game instead of jumping in at every sign of upswing in the market.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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