Data for charts are sourced from FRED, OECD, Eurostat, IMF, BIS, Market Watch, Yahoo/Google Finance, Investing.com, COT, Bloomberg or Quandl unless otherwise stated.
Financial market pundits are a bit like dogs chasing cars; they wouldn’t know what to do if they caught one. And so it is that after trying to figure out whether the economy and markets would achieve a soft landing in the wake of the post-Covid tightening cycle, no one quite knows what to think now that the soft landing appears to have arrived.
Let’s list the key requirements for a soft landing.
Read MoreAccording to U.S. Treasury Secretary Janet Yellen economists who predicted that a sustained period of high U.S. unemployment—and perhaps even recession—would be needed to bring down inflation are now “eating their words”. This follows earlier comments by Ms. Yellen last month that a soft landing is “on track.” Claudia Sahm, a US macroeconomist, agrees. In an interview with the FT earlier this month, she says:
The soft landing is not here yet. But it is in the bag.
Markets seem to agree with the assessment by the Treasury Secretary and Ms Sahm; bonds have rallied like a bat of hell in the past month—temporarily pegged back by a semi-hot NFP report on Friday—and equities are in a good mood too. November, I am reliably told by the financial media, was the best month for a standard 60/40 portfolio … ever. And why wouldn’t markets be celebrating? Inflation in the developed world is now falling rapidly, and what was a significant inflation shock in core prices has now been turned on its head, as the charts below show.
Read MoreThe prevailing mood in global macro discussions seems to be as follows; inflation is past its peak, but it is set to remain a lot higher for a lot longer than initially anticipated, forcing central banks to continue hiking, keep rates higher for longer, or a combination of the two. The interest rate shock in the UK, as markets have adjusted their expectations for the BOE bank rate higher, and hawkish comments from the ECB are the two most obvious cases in point in developed markets. But a surprise hike by the Bank of Canada, and a larger-than-expected hike in Norway have added to the sentiment. We only really need the Fed to be forced into a hawkish turn to complete the narrative. This shift is important for investors. We are not just trying to calibrate when central banks will pause their hiking cycles—probably soon—but we’re also increasingly discussing, and pricing, how long rates will stay elevated, and whether central banks will have to resume hiking before they cut. Higher-for-longer, or #H4L, is already a trending hashtag on FinTwitter.
Read MoreCentral bank hiking cycles in the developed world are slowly but surely coming to an end, raising the question of whether they have pulled off a soft landing, defined as a fall in inflation back towards target of around 2% without a meaningful decline in output and rising unemployment. On the face of it, the answer to this question is a resounding no. Interest rates in Europe, the UK and the US are up anywhere from 300 to 450bp in less than a year, driving up bond yields , and pushing yield curve inversions to near record levels. Anyone using these data points to predict what comes next, using historical relationships, will conclude that the wheels are about to come off in developed economies and their financials markets alike. The difficulties in the US regional banking sector is, in this case, simply a canary in the coal mine, warning of bigger shocks to come. The investment implications of such a view are simple; short equities and long short-term government bonds.
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