Equity & Debt Capital Markets: Global Macro Observations

Equity & Debt Capital Markets: The US Central Bank raised interest rates by 75 bps on July 27th as expected. This takes the Fed Funds target range up to 2.25%-2.50%. Powell has guIded the markets to expect further interest rate increases in the meeting(s) ahead including the Sept. 20-21 meeting. The question is whether the Fed will hike 50 bps or 75 bps at this meeting. Either way, the Fed Funds rate will be approximately 3% by end of September, 2022. With a 3%+ Fed Funds rate likely over the near term, the US interest rate curve is very expensive (meaning yields are too low) at below 3% all the way out to 30-year bonds. When considered in the context of the recent 9%+ annual inflation print, the yields are outright wackadoodle.

Bond yields across the curve and across the globe are very likely to rise steadily and appreciably ahead. While the magnitude of the move is yet to be determined, we are at yield levels relative to inflation where I comfortably believe the rise in market interest rates will be measured in the 100s of basis points. The fundamental combination of rising overnight interest rates coupled with global inflationary pressures far steeper and longer lasting than anticipated, point to further sharp declines in bond prices. Make no mistake, we are in a bear market for bonds. One needn’t be a technical analysis genius to observe that the trend in bond yields is higher despite the current brief pause we are experiencing over the past couple of weeks. Investors should take the chance to unload yield sensitive securities while the getting is good.

As for stocks, the market is exhibiting classic bear market activity. Bear markets tend to fall precipitously and then plateau and chop around sideways until there is general exhaustion and apathy amongst short sellers at which point the market resumes it’s next leg lower. It is telling that both stocks and bonds failed to move lower on the higher than anticipated June CPI and PPI numbers. Price action dictates that we are in the midst of a countertrend rally which can be vicious as shorts are forced to cover. The current stability of bonds is reinforcing the notion that inflation is softening anecdotally and the economy is weakening to a point where Central Banks may not need to be as aggressive in hiking rates to quell inflation. I believe this notion is fallacious. Even further moderate rate hikes and a slowing of inflation make 5-year yields under 3% and 10 -year notes at 2.62% look absurd. The markets are still awash in central bank provided liquidity and we’re merely at the beginning stages of the reversal of excess liquidity. Stocks are in a bear market, the trend is lower, the phenomena is global and investors should take this chance to exit risk assets. More likely, investors will attempt to buy this dip and provide fuel for the next selloff after this current respite.

On a longer term basis, the overall direction of risk assets will be heavily influenced by Central Banks’ posture toward liquidity. This has been true during the bull market when central banks injected unprecedented amounts of liquidity into the system. In an effort to dampen inflationary pressures across the globe, central banks must extract liquidity from the system and markets will follow downward. It is more than coincidence that equities, bonds, cryptos, NFTs, SPACs, private company valuations, etc. are all down markedly at the same time. Different stripes of the same liquidity fueled Zebra.