- The global economy is flashing signs of rate-related stress, with rising delinquencies in US consumer loans and a spike in corporate bankruptcies across the world.
- However, the US economy continues to post strong economic data and the labour market and consumer spending remain robust. The war in the Middle East has further complicated the outlook.
Central banks around the world continue to walk the tightrope as they battle to dampen inflation while at the same time trying to avoid tipping their economies into deep recession.
The US Federal Reserve and the Bank of England (BoE) both held rates steady for the second successive meeting this week. Last week, the European Central Bank (ECB) and the Bank of Canada also opted to keep rates unchanged.
However, policymakers continue to warn that additional monetary tightening may be necessary in the face of multiple challenges. The Fed’s benchmark rate stands at between 5.25% and 5.50%. The BoE’s benchmark rate remains at 5.25%.
The question investors face is no longer ‘how high?’ but ‘how long?'
“The question investors face is no longer ‘how high?’ but ‘how long?’,” says Lewis Grant, Senior Portfolio Manager for Global Equities at Federated Hermes Limited.
“It may not take a recession to control the economy and provide the right opportunity to cut interest rates, but a slowdown in growth will likely be required,” Grant adds.
“This earnings season is exposing the cracks as we are seeing a greater number of companies failing to deliver. This could hint at the slowdown the Fed needs to control the macro environment. Even so, the macro cogs turn slowly and we won’t see real clarity until the next earnings season,” he adds.
Rate-related stress
For investors today, the big question remains whether a US recession is looming or if a ‘soft landing’ remains feasible, says Filippo Alloatti, Head of Financials (Credit) at Federated Hermes Limited.
“The global economy is flashing undeniable signs of rate-related stress such as rising delinquencies in US consumer loans, and a spike in corporate bankruptcies across the world, while ratings agencies warn of a coming surge in debt defaults,” he says, adding that bearish observers point to the current state of the yield curve, which first inverted in mid-2022, as evidence that an inevitable economic slowdown is close.
Figure 1: Two-year versus 10-year US treasury yields (last six months)
However, the US economy continues to post strong economic data and the labour market and consumer spending remain robust. The war in the Middle East and potential oil price volatility have complicated the outlook further.
Bond markets rallied after the Fed meeting as some investors bet its rate-rising cycle may be at an end. Yields on 10-year US Treasuries had dipped to 4.68% at 16:30 GMT, after falling 19.7bps on Wednesday in one of the security’s best days since the banking turmoil in March. “The Fed, just like the bond markets, is betting the US economy will keep expanding and disinflation will continue,” Alloatti adds. In the UK, the yield on the 10-year gilt fell to 4.3%1.
European stock markets rallied on Thursday, with the pan European Euro Stoxx 50 closing up 1.9% and the UK blue-chip FTSE 100 ending up 1.4%2.
Grant adds: “Stability in rates will support value opportunities in the short term. As uncertainty remains, we continue to expect quality stocks to perform well. We anticipate a split in prospects for growth names: earlier stage companies will be penalised for burning cash in the face of changing consumerism. However, those with strong balance sheets and whose growth can tap long-term secular change – sustainability being the most obvious – are set to be well positioned when interest rates are [finally] cut.”
For further insights on global bond markets please see: 360°, Q4 2023
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1 Bloomberg as at 2 November
2 Bloomberg as at 2 November
