For the third consecutive year, the forecasts relating to the prospective dynamics of the international securities markets cannot be deduced from the possibility or otherwise of an economic recession starting during the year. This hypothesis had already been aired by experts in 2022 and reiterated at the level of a generalized consensus in 2023, only to prove fallacious until now.
This year, too, opens with similar forecasts of a generalized recession starting from mid-year, justified, as in the previous two years, by the need for central banks to tackle potential inflation through a restrictive monetary policy, by the soft landing of the European economy, by China’s difficulties in emerging from its deflationary spiral, by the impossibility of the US economy being able to maintain the 2023 nominal GDP growth of 6% and by the recessionary signal coming from the negative slope of the yield curve both in dollars and euros. To try to refute this dominant recessive thesis, we can start from this last indicator whose traditional predictive validity is strongly affected by the anomalous level of the duration premium of US government bonds. In practice, breaking down the bond coupon reveals three parts of it, consisting of the primary direct relationship with the discount rate, the risk premium, which is insignificant for government bonds and the duration premium, which the market requires in relation to its expectations relating to long-term rates.
According to logic, this premium should grow in relation to the duration, but its level can be strongly distorted by anomalies in the issuance and demand of the securities in question. Already in the aftermath of the pandemic, the premium had become largely negative, only to return to positive territory in 2021, and then resume its decline in relation to the monetary decisions of the Fed and the US Treasury starting from the end of 2022. In fact, the choice of authorities to issue mainly short-term bonds rather than 10-year bonds and the high degree of liquidity in the US financial system have artificially depressed the premium by around 100 basis points, thus adjusting the current 10-year yield, which is 4.10%, to rise above 5%, thus flattening the curve which would therefore deny the recession hypothesis. Even the statement that the main central banks have been restrictive from an anti-inflationary perspective, inducing a probable recession, should be taken with a grain of salt given that since October 2022 the FED has only reduced its balance sheet by 1000 billion out of the almost 9000 of the initial total, while the market expected a reduction of at least 2,500 billion. Furthermore, the central bank has continued to inject surreptitious liquidity through the reverse swap mechanism with the banking system, especially in the aftermath of the regional banks’ liquidity crisis last spring, with the result that the expected credit crunch is marginal. The sharp increase in the cost of money also impacted the US economy much less than expected, thanks to the long wave of the expansionary fiscal policy launched in the aftermath of the pandemic which allowed companies to reduce production capacity at the expense of the state while the previous decade of almost zero cost of money made it possible to satisfy long-term financing needs, considerably reducing the need for it during the rate rise phase.
But the key factor for the stability of the global economy is represented by the possibility that after three years of stagnation the Chinese economy will regain its lost momentum. Since last summer, the Chinese central bank, PBOC, has radically changed its strategic objectives, abandoning the strenuous defense of the exchange rate of the Yuan against the dollar in favor of its gradual depreciation which favors exports and therefore economic growth. Therefore, liquidity was created for the equivalent of 350 billion dollars already by last November, while in recent days a 50 basis point cut in the rate on banks’ compulsory reserves was implemented, which frees up around 140 billion dollars. Furthermore, in light of the bankruptcy of the real estate giant Evergrande in Hong Kong, the issuance of a new government policy on real estate loans is expected shortly. If the Chinese bet is won, there will be no global recession and investment in equities will be rewarded in 2024, especially in emerging Asian stock markets.
Nicola Bravetti Data Source: Bloomberg
“This report cannot – nor can – be consider a solicitation to invest in financial instrument”