- Macro Strategist
Singapore, Intermediary
Change
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
While it’s not easy to assess today’s fast-moving and uncertain macro environment, from my perspective, it certainly fits the new regime’s mould of increased market and cycle volatility. So far this year, we’ve already oscillated between recession, a Goldilocks scenario, reflation and banking turmoil … and it’s only March. So where does this leave investors?
While the dizzying rate of change we’re currently facing may be atypical, a feature of the new regime is that cycles move more quickly through their different stages, with a much wider distribution of potential outcomes. It’s important, therefore, to be nimble and open-minded when considering the key questions that need to be addressed. In this instance, I think the two most important macro questions are:
- To what degree will the shockwave initiated by the collapse of Silicon Valley Bank cause bank lending to tighten, and could it ultimately lead to a deflationary credit crunch?
- Will policymakers react quickly enough, or will they be slowed down by the previous backdrop of a reaccelerating cycle and hence run the risk of exaggerating the downturn?
How much will bank lending tighten?
There is little doubt that the challenges faced by the financial sector will adversely impact the real economy through tighter credit conditions and lower loan growth, at a time when real wages are already under pressure. Nonetheless, it’s too early to say with conviction what the likely outcome will be. Will tightening be contained and therefore simply act as a substitute for more rate hikes from the US Federal Reserve (Fed) and the European Central Bank (ECB)? Or will it become more pervasive and translate into a credit crunch that could push the economy into recession, and ultimately reintroduce deflation back into the distribution of potential outcomes?
While there is tentative evidence in the US and, to a lesser extent, Europe that some tightening may have already taken place, current data do not fully reflect the latest developments, and estimating the full magnitude of tightening will take time. For now, I expect markets to remain volatile and largely driven by headline news, particularly relating to the banking sector. However, I think the market’s focus is now shifting from inflation to recession, and as central banks pause to assess, the market will look to price the next move in rates as a cut rather than a hike.
Will policymakers act quickly enough?
There’s a risk that central banks may not act soon enough to prevent a deep recession given the accelerating cyclical backdrop, with a 40-year low in global unemployment and still-high inflation across most countries. However, I think the opposite is more likely. At the time of writing, the distribution of potential outcomes is exceptionally wide — with fat tails — and attaching probabilities to these outcomes is hard for policymakers. To the extent that history is a guide, it’s noteworthy that, in similar situations, policymakers have tended to set policy depending on which outcomes they wanted to avoid the most. Given the choice between financial instability — with the attendant risk of deflation — and inflation, central banks are likely to seek insurance against a scenario of financial instability and deflation, even though inflation remains very high.
After the recent hikes by the Fed and the ECB as well as the Bank of England, the Swiss National Bank and Norges Bank, we are starting to see signs that such a shift in policymakers’ thinking has begun. The Fed’s balance sheet is now expanding again and the ECB is making the outlook for rates explicitly conditional on how conditions in the financial system develop, while the Bank of Japan is no longer under pressure to abandon its yield curve control framework.
If tensions in the financial system persist, central banks may well cut rates in the second half of this year, despite the persistence of above-target inflation and high employment rates. Even a return to full stability in the financial system is now unlikely to lead to an automatic resumption of rate hikes as the hurdle for raising interest rates has become a lot higher than before the shock. Paradoxically, I think the current crisis has restored central bankers’ faith in monetary policy being able to achieve their goals, albeit with a lag, so they may be more inclined to wait to see the full effect of their policies. And even if the problems currently experienced by the banking sector are fully resolved, the shock has likely heightened concerns among policymakers that the financial system is now vulnerable to a sudden upward repricing of rates and that tightening comes with a higher cost.
What’s the path forward?
We may be at the point where tightening credit conditions will drive a downturn without the need for more rate hikes. While cyclical inflation tends to fall during downturns, the recessions of the 1970s prove that this may not be sufficient to break structural inflation. The alternative scenario of a credit crunch and a deep recession would achieve that result, but regulators are unlikely to stomach such a scenario given the inherent risk of instability and deflation. The recent shock may well cement the path to embedding higher medium-term inflation, higher risk premia and higher long-term interest rates. However, to get to that point with any level of conviction, we first need to understand the recession risks ahead, which will be a key focus of our research.
Expert
Related insights
Showing
of
Insights Posts
How to nurture a growth mindset in a higher-yielding landscape
Continue reading
12
min
Article
2025-03-31
State of the credit markets: Does cash rule everything around us?
Continue reading
Quick Take
2024-06-30
URL References
Related Insights
Read next
Showing
of
Insights Posts
How to nurture a growth mindset in a higher-yielding landscape
In a higher-yield world, can fixed income deliver meaningful growth? John Mullins, Supriya Menon and Alex King explore how high-yield bonds may offer a powerful opportunity for growth - as well as a cushion against uncertainty.
12
min
Article
2025-03-31
The shifting liquidity landscape: What’s at stake?
The beginning of the end could be in sight for the Federal Reserve’s quantitative tightening (QT) program. US Macro Strategist Juhi Dhawan considers the Fed's next steps and what they could mean for banks, liquidity, and markets broadly.
Quick Take
2025-01-31
US regional banking sector update
We explore how banking regulation and legislation could impact US regional banks, including highlighting the potential for M&A activity and for dispersion to drive long/short opportunities.
Article
2024-08-31
Financials amid rising dispersion
We explore why we believe dispersion across stocks, sectors, and geographies is supporting numerous secular themes in long/short investing in financials.
Article
2024-09-30
State of the credit markets: Does cash rule everything around us?
Fixed Income Portfolio Manager Brij Khurana outlines the state of the credit market today, compares historical periods of quantitative easing, and warns credit investors of cash scarcity in the near future.
Quick Take
2024-06-30
FX outlook: Is USD exceptionalism withering away with the Fed hiking cycle nearing an end?
Discover the status of the USD today, learn where the greenback may be headed going forward, and understand why.
Quick Take
2024-01-31
Did the Fed just make a policy error?
Did the Fed just make a policy error? All things considered, Fixed Income Portfolio Manager Jeremy Forster thinks the answer is yes. Learn why and what the implications could be.
Quick Take
2024-05-31
How do bank failures impact fintech?
Global Industry Analyst Matt Ross analyzes the ways in which recent US bank failures could impact the fintech sector in public and private markets.
Quick Take
2024-04-30
Three macro assumptions that could be just plain wrong
Fixed Income Portfolio Manager Brij Khurana offers his non-consensus take on three entrenched, but potentially flawed, beliefs in today's market environment.
Quick Take
2024-04-30
Commercial real estate: Seeking shelter from the storm
Finding potential opportunities in commercial mortgage-backed securities these days is all about knowing where to look, says Fixed Income Credit Analyst Carolyn Natale.
Quick Take
2024-04-30
Lessons from 2008: Stress testing portfolios in today’s market
While very different from 2008, the current market environment makes a strong case for portfolio stress testing. Gregg Thomas, Co-Head of Investment Strategy, offers suggestions for improving the process, including assessing factor positioning and reducing recency bias.
Quick Take
2024-04-30
URL References
Related Insights