Central Banks Succumbing to Market Forces
Chaotic Global Macro at Centre Stage
The global macro situation remains complex and chaotic filled with conflicts, cross currents, vastly diverging and often opposing interests:
- Russia’s unlawful war on Ukraine
- China’s misguided COVID policy
- Global energy and food crisis
- Unprecedented sovereign debt levels
- Derailed inflation rates
- Fragmentation in financial markets
- Increasing financial stability risk
We live in extreme times with policymakers taking unprecedented decisions. Key to investment success is to think out-of-the-box in regards to the global macro situation and related risks and opportunities.
EU, G7, NATO Summits of Historic Importance
Coming days and weeks are packed with historically important summit meetings of Western policymakers:
- European Summit in Brussels (June 23rd-24th)
- G7 Summit in Schloss Elmau, Germany (June 26th-28th)
- NATO Summit in Madrid (June 29th-30th)
Expect some intense discussions and far reaching decisions in the context of Russia’s military aggression in Ukraine. However, some decisions will be immediate, and others lagging as is customary within a group of value and rule sharing democracies seeking to compromise.
In recent months Western alliances have been significantly strengthened, finding purpose and resolve in the face of adversity. Step by step they will prevail in multi-dimensional confrontations against aggressors such as Russia and other autocracies by expanding and deepening the political, economic and security framework within the G7, EU and NATO.
Recession – not Stagflation
It is basic economics that the figures don’t add up – US unemployment rate below 4%, US inflation rate above 8%, US 10 year treasury yields below 3.5%. In consequence, only higher real interest rates and a recession with increased unemployment, demand destruction, falling corporate earnings and rising default rates can stabilize the unhinged inflation situation and lay a sound foundation for a new growth cycle.
Inflationary forces have moved from transitory to entrenched, decisively accelerated by the war in Ukraine. Therefore, lagging monetary policies have to earn credibility and effectiveness by enforcing restrictive and resolute strategies.
The way to economic and monetary normalization will be painful and hardly via a lengthy stagflation, continued muddling-through policies and a wishful soft landing.
Rising Risk of a Financial Accident
Capital markets are forcing the hands of monetary, fiscal and regulatory policymakers. Risks of a financial accident are constantly increasing due to rising interest rates, widening credit spreads and tightening lending standards and liquidity conditions.
Some financial institutions, be it structurally unprofitable banks and/or over-leveraged shadow banking institutions, are not far away from needing an untimely capital increase or a bail-out.
European Fragmentation to Capital Markets Union
No doubt, policymakers will again do whatever it takes in the face of a failing financial institution.
Central Banks’ inflation targeting policies are completely derailed and sovereign debt levels high yet increasingly divergent. Just watch the widening German and Italian Government bond spreads.
Increasing fragmentation risks will not be solved by policymakers in Frankfurt and Brussels continuing to bend and hollow strategies, tools and rules.
Inevitably, they will have to make decisive steps towards structurally progressing the overall institutional framework. This means the overdue realisation of a European Banking and Capital Market Union.
Asset Allocation – Nothing is what it was
We are sticking to our defensive investment outlook. Currently we are looking at the biggest bond market downturn of all times, equity markets have entered bear market territory and hyped investments such as cryptocurrencies, meme stocks and SPACS have collapsed.
These trends are far from over as relevant risk indicators such as volatility, credit spreads and default rates are merely beginning to overshoot.
Capital markets are adapting fast to new economic realities and are in search of a new equilibrium. Meanwhile, investors are becoming more risk averse and prefer safe haven assets.
Extraordinary Times create extraordinary Opportunities
Extraordinary times and market conditions will also create extraordinary investment opportunities. For one competitively positioned and well managed and solidly financed businesses in industrialized countries will be available at realistic prices.
And clearly, selected developing markets are becoming attractive once the FED starts a new easing cycle and the USD will top out.
Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA