Grumpy investors see the bright side of growth risks


I have the right to say this because I myself come from a farming background: farmers complain constantly, about everything. Too wet, too dry, too hot, too cold, etc etc. Investors are not so different.

The first months of this year brought an inflationary panic. Bonds have fallen sharply because they are allergic to inflation, which is eating away at their (rather meager) fixed payments. Stocks fell because fund managers decided the US Federal Reserve would hand out half-point rate hikes like candy at every meeting in an attempt to bring inflation down. The “all rally” has collapsed and left many fund managers with nowhere to hide. The horror!

Now the inflationary panic seems to be easing. The new worry in town is the possibility of a serious slowdown in growth or even, in the worst case, a real global recession. Please adjust your big market stories accordingly.

The key idea here is that monetary policy is a pretty crude tool. Inflation has soared well above the targets set by major central banks, forcing policymakers into aggressive tightening, with rate hikes and cuts to the huge balance sheets they have built up with asset purchases. since the 2008 crisis, completed of course in 2020.

The problem is that central banks are limited in their ability to control the kind of inflation we are suffering from. They cannot end Covid lockdowns in China, produce microchips or manufacture peace in Ukraine. Unless they can solve this third problem in particular, they are probably unable to lower energy prices and, by extension, temper workers’ (perfectly reasonable) demands for a wage increase.

“They want to bring inflation down, but they know they can’t do anything about the energy part,” says Gareth Colesmith, head of macro research at Insight Investment. “If they really want to get the situation under control, they have to do something about the labor demand, because they can’t do anything about the supply. So you induce a slowdown, and that carries a risk of tipping into a recession.

A policy error is one way to induce a recession, but not the only one. However, economic data releases in the United States are now often below market expectations. Citi’s US economic surprise index plunged to its lowest level since September.

A “true” recession – not another quarter of moderate contraction driven by technicalities, but a deep and lasting decline – is far from a certainty. This is clearly not what businesses and households want to see after an already trying few years, nor what policy makers want to conceive of.

But you can tell the idea is taking root with investors from multiple angles. The main one is that government bond prices have stabilized after a sharp drop, suggesting that not only are inflation expectations starting to boil, but that investors are bracing for slower growth and even a slowdown in central bank tightening. The benchmark 10-year US Treasury yielded 2.91% on Thursday – high by standards in recent years, but well below the peak above 3% seen in early May. Likewise, the dollar retreated.

But of course, Wall St and Main St are very different beasts. A cooling dollar and lower bond yields are, all else equal, good for stocks. Already, the rebound is pronounced – the benchmark S&P 500 index of blue-chip U.S. stocks has climbed 9% since its May 20 low. The MSCI World Index is up a more modest but still impressive 6 percent. hundred. Corporate bonds also rebounded.

The big question, however, is whether the latent fear of growth will be enough to derail Fed tightening. Barclays, for its part, doubts it. “The Fed is unlikely to blink until inflation expectations are definitively re-anchored,” bank analysts wrote in a note to clients. “We think the Fed will want to see evidence of much lower inflation and/or much tighter financial conditions” before tearing up its plans, he said. “Until then, expect choppy markets to continue.”

He added that while hedge funds were big sellers of equities in May, mutual funds, which have injected some $1.3 billion into the asset class since 2020, have only just started to sell out. remove. If recession fears persist, “there could be another $350 billion in equity sales down the road” from these funds, Barclays analysts said.

David Riley, chief investment strategist at BlueBay Asset Management, also thinks the latest rally in stocks and other risky assets is likely to be a blow. “Don’t fight the Fed,” he says. Policymakers actively want to see higher borrowing costs that help calm some elements of inflation without the central bank having to rush rate hikes, he adds.

Instead, if markets continue to sail higher, it might be wise to anticipate rather more hawkish comments from rate setters. “I’m skeptical about how long this mini-rally will last,” he said.

For now, we are back in the zone where bad news on economic growth is good news for riskier markets because it means less upward pressure on rates. If you can handle the volatility and secretly enjoy complaining, that’s a perfect combination.

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