- The voracity of market moves since New Year belies the underlying deterioration in the major economies. Certainly, there are vulnerabilities exposed by the start of US rate tightening, & China slowing. But, the danger now is the reaction outweighs the reason.
- Sharp equity declines are traditionally associated with key macro shocks &/or a toxic policy mix. Current policy can hardly be accused of being toxic, suggesting China & the US Fed are the main culprits. Yet, their main macro risks should still be contained.
- Even with ‘true’ real growth of just 3%, China in 2015 will have generated over two years nominal growth equivalent to the entire GDP of Spain. Expecting it to carry on doing more was unrealistic.
- Then there’s the Fed. Its expectation of raising the funds target to 3½% after 2018 looks unrealistic. But, we doubt it will be dissuaded from hiking again in this cycle. We expect two more 25bp US rate hikes by Christmas, taking us to a still low 1% ‘peak’ rate.
- Which suggests another two years of negative real rates - in the US & UK - on top of the six years we’ve had. The ECB & BoJ will have to make their rates more negative, aiming to keep long yields down.
- A complication for the UK, though, is its EU referendum. Our base case is Brexit is avoided. But, uncertainty will build, & should Brexit occur, the BoE may have to be the biggest sponsor of gilts, via QE.
- China has the wherewithal to soften its landing, but must avoid a policy ‘face-off’ with the US. Renminbi devaluations are an extra incentive for the Fed to take only baby steps. Fortunately, China should prefer ‘drip-feed’ devaluations to help its balance sheets.
How grizzly is this bear market?