‘Risk-on’ for Markets
Stock markets are ruled by “sentiment” which drives money in and out of the markets. Bullish sentiment is described as a risk-on period while the bearish sentiment is called risk-off. The US market and economy have a profound influence on emerging markets and it is worth paying attention to them. Until the last week of October, US markets were in a risk-off mode, battered by the relentless rise in the yields of US bonds.
 
The 10-year yields hit 5% in the third week of October, a level last seen in 2007, as the monetary policy seemed to favour “higher (rates) for longer”; to control inflation, the US Federal Reserve (Fed) pushed the benchmark interest rate in just 16 months from 0.25% in March 2022 to 5.5% by July 2023, one of the most fierce rate hikes in history, taking the rate to the highest level in 22 years.
 
Last week, after the monetary policy meeting, the Fed announced a pause for the second time. It said that the bond market, by pushing up yields, was doing its job of cooling down the economy; so further rate hikes are not needed for now.
 
Traders and investors have interpreted this as the end of rate hikes with a high chance of rate cuts after six months, and so, have switched back to risk-on mode. The benchmark index S&P500 rallied a sharp 5.85% last week. The Indian market, after a week of decline, has stabilised and looks set to follow the “mother market” that is the US stock indices, by going higher.
 
The question is, is this another deceptive bounce or is the market, which is always forward-looking, discounting all the negatives and climbing over the wall of worry comprising wars, rate hikes, global trade weakness and the rise of protectionism? I believe the US economy is not yet out of the woods and, to the extent it influences the global market, one should remain wary.
 
Calamity Postponed?
 
The US war over inflation may be over for now but we have not seen its full aftermath. While US consumer inflation has dropped from a year-over-year peak of 9.1% in June 2022 to 3.7% last month, it is well above the Fed’s 2% target.
 
Indeed, it would be facile to think that the sharpest rate increase cycle over just 16 months would damage the economy only minimally. Rate increases hit the economy with a lag and we are yet to see how small businesses and consumers will deal with the massive rise in interest rate burden. As long as the Fed rate and long-term bond yields remain high, the negative impact on the US economy continues.
 
At 5.50%, the Fed’s benchmark rate is 2 percentage points above headline inflation. A 2% real yield is a serious damper on the economy and has been a headwind for stocks historically.
 
Here are some pointers. The US ISM manufacturing index for October dropped to 46.70, marking the 12th consecutive reading below 50, which indicates contraction. The index was 49 last month and 50.20 one year ago. The already unaffordable US housing market is getting worse. The housing affordability index of the National Association of Realtors has hit a 40-year low.
 
This is not surprising because, nationally, the average long-term fixed mortgage rate is nearing 8%, its highest level in 23 years. Heavy truck sales are falling off a cliff.
 
On Friday, shipping giant Maersk, a bellwether for global trade, announced plans to reduce its workforce by more than 10,000 people, and said it expected profit to be at the low end of prior guidance. The stock fell 18% to its lowest level since October 2020. “Our industry is facing a new normal with subdued demand, prices back in line with historical levels and inflationary pressure on our cost base,” CEO Vincent Clerc said in a statement.
 
Remember Labour?
 
A long period of prosperity, helped by cheap capital (due to extremely low interest rates) and booming global trade, has made us forget the wider social and political impact of high interest rates and protectionism that were a reality in the 1970s.
 
Think of the impact of economic stress on another factor of production: labour. Workers' strikes in the US are at their highest since 2000, with 4.1mn (million) days lost in August to labour activism.
 
According to Bloomberg, unions are winning big for the first time in decades. Workers are resetting their expectations and demanding more than they did a few years ago, in response to the higher cost of living. Unions are negotiating large contract settlements, 25% to 28% pay raises, more paid time off, and more health benefits.
 
It takes 24 months for the Fed tightening cycle to show up in the US labour market. It is 20 months now, after the first rate hike in March 2022, and the unemployment rate in October rose to an almost two-year high of 3.9%. Jobless claims are up 9% in the past six weeks and 26% in the past 12 months. One-third of the jobs added were government hires.
 
Also, there were downward revisions to the August and September payroll numbers. Indeed, payroll numbers have been revised downwards in every single month of 2023. The last time this happened was during the great financial crisis of 2008. All this does not mean that the stock market will not rise over the short term.
 
But it is too early to conclude that the “worst is over” for the US economy; the lag effect of extremely high interest rates is still on the cards. Will emerging markets like India, escape from it?
 
(This article first appeared in Business Standard newspaper)
 
 
Comments
Kamal Garg
7 months ago
While the article is well written prophesizing the all expected global stock market gloom and doom, but, every time, the market was always caught unaware with a new tiger with new stripes out of the cage. This kind gloom and doom prophecy has been going on for the last more than a year but still all the global markets including India, despite record breaking interest rate hike cycle, has been going high every other day.
kuldip46
8 months ago
Way back in December 1985, the late Saint Scholar Giani Naranjan Singh Ji said,

"Come the turn of the century, the economy of the world will start to go downhill.”

To the question, “ Why will the economy go downhill? ”

The Saint Scholar replied,

"We will be moving from the Age of Falsehood to the Age of Righteousness.”

No one has ever experienced the change from Kaliyuga to Satyayug. Hence, none of the hypotheses will probably be correct.

The late Saint Scholar Giani Naranjan Singh Ji said that in the 21st century, India will lead the world.

We are heading for extremely interesting times.
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