From Aggression to Caution: Monetary Policy in Transition
Central banks worldwide are halting their aggressive monetary tightening policies in response to a global economic slowdown and declining inflation. This shift, marked by pausing rate hikes and planning cuts, is coupled with governments, particularly the U.S., stimulating their economies. Since October 2022, the Fed and the U.S. Treasury have been generating liquidity to support the American economy. However, the rate hikes implemented from 2022 to 2023 are expected to gradually exert a negative impact on the U.S. economy, leading to potential recessionary conditions and deflationary pressures in 2024.
The Fed has declared a tentative victory against inflation, as the overall decline in inflation rates is evident. Although it remains above their target, December's inflation print is anticipated to be below 3% year-over-year. So far, the US economy has shown unexpected resilience, but as the effects of rate hikes emerge, they are prompting the Fed to adopt a more proactive approach compared to the 2008 or 2020 crises.
If our view is correct about the economy slowing down in 2024 and potentially entering a recession, and if the government struggles to fund itself, then its capabilities to stimulate will be very limited. Hence, the Fed already has to start cutting rates and potentially resume QE or force banks to buy bonds at some point in 2024. We think that they will want to be very accommodative to help the incumbents be seen in a more positive light and avoid a Trump reelection. Faced with a global slowdown and the US government facing funding issues, it makes sense for them to do more, especially when the first signs of a hiccup arise.
As inflation has been falling due to falling energy and food prices, and as markets have been resolving issues that arose during the pandemic, bonds are rising and the USD is falling. All these factors are resulting in an increase in liquidity, and we think that this market increase in liquidity will last for a while longer, or until oil bottoms around $50-60/barrel. So far, as bonds rise, stocks are rising, but it is possible that we could have a moment where bonds rise and stocks fall.
Stocks have been thriving and have recovered almost all their losses from 2022. In our view, there is a potential for a final push, leading to a potential bull trap. Some indices have made new highs or new ATHs, but others haven’t. We think stocks have about a 3-4% upside from here before a top, and precious metals do too. The current market conditions are clearly extremely overbought, while sentiment and positioning are getting very bullish, which is bearish. Through our analysis, we think that the market simply hasn’t reached that tipping point of sentiment and positioning getting extremely bullish, although we think we are probably a month away from the top being in.
For now, there's no clear peak for risk assets, indicating potential growth across markets. The market rally, partially fueled by the increasing liquidity, might continue for a while, but this does not guarantee it will be sufficient to sustain long-term growth. Over the past year, the US economy showed incredible resilience; however, caution is advised due to the lagging effects of previous rate hikes. Much has been said about why interest rate hikes when debt is high can be stimulative: the fact that most borrowers fixed their mortgage rates below 3%, the composition of the bond issuance by the Treasury, and now banks borrowing from the Fed using the BTFP facility at lower rates than the Fed rate.
Yet, in the end, we need to remember that interest rates act on the economy with long and variable lags, and it usually takes about 2 years for the hikes to have an effect on the economy. Maybe in this case, it takes longer because of all these different factors, but let’s not forget that the global economy hasn’t been in great shape for years, and in 2022 and 2023, we saw the fastest and largest rate hikes, going from massively negative real interest rates to extremely positive interest rates, not just in the US but in many countries across the globe.
In conclusion, the current economic landscape presents a complex mix of challenges and opportunities. While recent measures have shown some effectiveness in controlling inflation, the lagged impact of aggressive rate hikes through 2022 and 2023 cannot be overlooked. The potential for a global economic slowdown and a U.S. recession in 2024 looms large, raising concerns about the government's ability to provide adequate stimulus in the face of funding constraints. Despite the recent rally in stocks and the temporary boost in liquidity, investors should remain vigilant. The market conditions, being extremely overbought with bullish sentiment, hint at a possible tipping point on the horizon. Therefore, while there is room for cautious optimism, prudence and a keen eye on evolving economic indicators will be crucial for navigating the uncertainties ahead.
The Fed has declared a tentative victory against inflation, as the overall decline in inflation rates is evident. Although it remains above their target, December's inflation print is anticipated to be below 3% year-over-year. So far, the US economy has shown unexpected resilience, but as the effects of rate hikes emerge, they are prompting the Fed to adopt a more proactive approach compared to the 2008 or 2020 crises.
If our view is correct about the economy slowing down in 2024 and potentially entering a recession, and if the government struggles to fund itself, then its capabilities to stimulate will be very limited. Hence, the Fed already has to start cutting rates and potentially resume QE or force banks to buy bonds at some point in 2024. We think that they will want to be very accommodative to help the incumbents be seen in a more positive light and avoid a Trump reelection. Faced with a global slowdown and the US government facing funding issues, it makes sense for them to do more, especially when the first signs of a hiccup arise.
As inflation has been falling due to falling energy and food prices, and as markets have been resolving issues that arose during the pandemic, bonds are rising and the USD is falling. All these factors are resulting in an increase in liquidity, and we think that this market increase in liquidity will last for a while longer, or until oil bottoms around $50-60/barrel. So far, as bonds rise, stocks are rising, but it is possible that we could have a moment where bonds rise and stocks fall.
Stocks have been thriving and have recovered almost all their losses from 2022. In our view, there is a potential for a final push, leading to a potential bull trap. Some indices have made new highs or new ATHs, but others haven’t. We think stocks have about a 3-4% upside from here before a top, and precious metals do too. The current market conditions are clearly extremely overbought, while sentiment and positioning are getting very bullish, which is bearish. Through our analysis, we think that the market simply hasn’t reached that tipping point of sentiment and positioning getting extremely bullish, although we think we are probably a month away from the top being in.
For now, there's no clear peak for risk assets, indicating potential growth across markets. The market rally, partially fueled by the increasing liquidity, might continue for a while, but this does not guarantee it will be sufficient to sustain long-term growth. Over the past year, the US economy showed incredible resilience; however, caution is advised due to the lagging effects of previous rate hikes. Much has been said about why interest rate hikes when debt is high can be stimulative: the fact that most borrowers fixed their mortgage rates below 3%, the composition of the bond issuance by the Treasury, and now banks borrowing from the Fed using the BTFP facility at lower rates than the Fed rate.
Yet, in the end, we need to remember that interest rates act on the economy with long and variable lags, and it usually takes about 2 years for the hikes to have an effect on the economy. Maybe in this case, it takes longer because of all these different factors, but let’s not forget that the global economy hasn’t been in great shape for years, and in 2022 and 2023, we saw the fastest and largest rate hikes, going from massively negative real interest rates to extremely positive interest rates, not just in the US but in many countries across the globe.
In conclusion, the current economic landscape presents a complex mix of challenges and opportunities. While recent measures have shown some effectiveness in controlling inflation, the lagged impact of aggressive rate hikes through 2022 and 2023 cannot be overlooked. The potential for a global economic slowdown and a U.S. recession in 2024 looms large, raising concerns about the government's ability to provide adequate stimulus in the face of funding constraints. Despite the recent rally in stocks and the temporary boost in liquidity, investors should remain vigilant. The market conditions, being extremely overbought with bullish sentiment, hint at a possible tipping point on the horizon. Therefore, while there is room for cautious optimism, prudence and a keen eye on evolving economic indicators will be crucial for navigating the uncertainties ahead.
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