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  • Richard Horswill

Don't get caught out by the bull

This article was written by Richard Horswill. All views and opinions expressed are strictly his own.


The global economic narrative remains all about the soft landing, and how the Federal reserve members have precisely measured the exact metrics to pull off the historically impossible. How, though, can we, as interested bystanders, really make sense of the Central Bank rhetoric, so that the messages that we have been receiving are convincing enough for us to believe that what they and the mainstream financial media are telling us is correct. This article attempts to provide some balance, and may point to some evidence that the elusive soft landing may just be a figment of the central bankers imagination as they desperately attempt to cling on to their reputations as our financial and monetary masters.


So many pundits are obsessed by the performance of stock markets and attempt to convince us that the global economy's past, present and future is predicated on this and this alone. Clearly this cannot be the case, however the intensity featured on the future of AI and Tech generally has pushed something of a hysteria in stocks with expectations that this new future, along with the supposed soft landing, will lead us into the next great bull market. Not only will big Tech benefit but some how the "value" trade will also come back into vogue, meaning overall corporate profits will again drive indices to higher than ever highs. This of course is also going to be accelerated by the central bank pivot as they are able to reduce interest in line with the way they have handled the sticky inflation that it has been their mantra to control. Wow, how could one not believe this fantastic narrative!


Of course, there are other markets that provide an alternative to this fluffy mainstream view that somewhat provide for an alternative narrative. Oil is very much a global economic indicator and seems to have been indicating the opposite to stock markets. What with war in Ukraine and Russian sanctions, OPEC 2 supply cutbacks, and now a Middle Eastern conflict which is spreading into the global energy and supply chain waterways of Suez, the Red Sea, the Gulf of Aden and the Arabian Sea, and despite all of these factors, the price of oil and the contango that has been prevalent in oil over recent months is definitely telling a different story. Global demand for energy is clearly down as demand destruction has been driven by central bank interference in the interest rate markets. This has undermined the consumer economies of the west in terms of personal disposable incomes, but also more importantly, have driven international bank commercial and industrial lending down as yield curve inversions have made lending significantly less profitable and thus more risky for bank balance sheets.


Moving on to the current interest rate picture, pundits continue to believe that lower interest rates and thus cuts to benchmark rates will drive a new euphoria. Unfortunately, typically when central banks need to cut rates it is normally a sign that they are behind the curve and they are panicking to catch up with the market. Yield curve inversion has been with us now for the best part of eighteen months and seems to be stubbornly intact whilst central bankers continue to tout their inflation fighting mantra which has all along been in my opinion more of a political decision rather than a market driven one. One particular interest rate indicator that has been relevant historically is a bull steepening in the yield curve, which is where the inversion in the curve flattens from the front end, i.e. the 2 year rate falls faster than the longer end of the curve and has negative connotations, so good for bonds but bad for growth as the market begins hedging appropriately for a negative scenario. (Bear steepening is the opposite, where the longer dated 10 year rate rises in line with central bank policy un-inverting the curve and having a positive connotation in the market). A bull steepening action indicates that the market is pressing the need for interest rates to go down and is suggesting a bad outcome such as a recession or worse if rates do not go lower. This is a reliable indicator of stress in the monetary system and thus financial markets. Using US dollar rates as the benchmark, the 2's 10's spread has flattened recently to a low of negative 20 basis points so was still inverted; however the sharp narrowing of the inversion is an indication that we should expect, within the ebbs and flows of the market, that a flattening or full un-inversion between the 2's 10's could well occur in the not so distant future. This typically leads to a negative market event forcing a swift change in central banks’ interest rate policy. It needs to be said that lower interest rates are not an indicator of potential future inflationary conditions. Quite the opposite, as interest rates are moving lower due to the requirements of investors ( and banks ) seeking safe and liquid assets in the form of government debt, forcing rates down which tightens bank lending in the economy, not loosening as many believe. Government debt competes with private sector investment, and thus in economic downturns government debt is seen as a preferable investment, reducing bank lending, which is a massive negative in a debt based system. It is also important to say that markets are not linear and therefore volatility will likely widen and narrow the inversion; however it is the trend that will ultimately provide the answer which seems highly likely to remain the bull steepening case.


To conclude, with much water under the bridge from the the March 2020 pandemic commencement, to the February 2022 invasion of Ukraine and beyond, the many economic theories and expectations that have flowed to and fro from transient to higher for longer, it now seems that 2024 will likely provide the answer to all of those strategies. The stock market casino will do its thing, but will likely take a temporary hiatus as safety and liquidity are sought until stability returns in the event of a crisis. If the oil price trend and bull steepening case for rates maintain their potency within the global economic mechanism, a continuation of a low growth world will predominate as the international global banking system, as in 2008, will not provide the funding necessary to allow a global economic resurgence. It seems to me that the choice currently between the interest rate "bull" steepening case and the central banker "bull" that we have had to put up with for far too long is an obvious one, but as ever it will be the market that decides.

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