Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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November 5, 2023

Are we there yet?


It was little surprise that central banks continued to pause their rate hiking last week. It had been well signalled. However, if investors expected the rate decisions, why did markets rally? There was the helpful news of a slowing US job market consistent with slowing economic growth (albeit the official US GDP data series hasn’t gotten the memo).

But of more significance was the Quarterly Refunding update from the US Treasury, which informed investors that the scale of bond issuance would be less than expected and tilted more to the short end of the curve. The impact of this technical update, one usually for bond nerds, illustrates how we have slipped into an era of fiscal dominance almost unnoticed.

Just as the Fed had given up the battle to control the curve, seemingly ceding control to bond investors, the Treasury stepped in to squeeze the shorts and show the bond vigilantes who was in charge. The question now is, for how long can they hold out?

Until the events of last week, the higher for longer mantra had taken hold, and investors expected something to break. Instead, they got news of a slowing jobs market, further Japanese easing, stimulus from Beijing, and fewer long-dated US Treasuries to buy before Christmas. It wasn’t as bad as feared, and short covering was required.

The question now is whether this readjustment is the end game for rising rates. Critically, risk assets need investment inflows. It remains too soon to know if we are at the turning point. Successive politicians have kicked so many cans down the road that bond markets still risk being buried in aluminium.

In this debate, there has been much focus on the liability side of the US balance sheet. Massive recent fiscal programmes of the Biden administration layered on top of growing entitlement programmes and mounting defence commitments add up to projections for debt issuance that are mind-blowing. How can the era of dollar supremacy endure these enormous challenges? There is much debate over the prospects for de-dollarisation in an increasingly multipolar world.

However, much less is said about the assets side of the US balance sheet. In short, the US economy has superpowers that many commentators commonly overlook. For all its issues, the dollar remains the world’s reserve currency with huge network advantages. It endows the United States with what Charles De Gaulle called its exorbitant privilege, making its Treasury Bonds the world’s prized financial collateral and helping it enjoy the broadest and deepest capital markets. Its equity market has a 70% weighting in the MSCI developed world equity index. As an economy, the US is self-sufficient in energy and most foods and has a tax base that, albeit under pressure, can fund fiscal programmes no other economy can get close to.

The reality of a “higher for longer” monetary policy has damaged the US economy, which grew last quarter by an astonishing 4.9%, far less than the rest of the world. As Treasury Secretary Connally told De Gaulle, it is our currency but your problem, and his words remain true today.

In this remarkably resilient but slowing economy, the US shows signs of being able to execute the improbable soft landing. However, we won’t find out whether its undercarriage is fully down and its glide path sufficiently shallow for some time. Meanwhile, Germany is leading the EuroZone into recession, leaving the UK caught in the middle. While lacking America’s superpowers, the UK does have more optionality than economies, such as the Netherlands, tied into Euro structures such as a one-size-fits-all monetary policy.

A couple of weeks ago, Dowgate’s Laurence Hulse and I, with Alyx Wood of Kernow Asset Management, had a podcast chat with Panmure Gordon economist and Times columnist Simon French on Why Invest in the UK? Simon believes that UK equities are at least 20% cheaper than equivalent developed markets adjusted for differences in sectorial composition and says the UK has not been this cheap since 1989. Its relative value to the US market is particularly stark. (And one might argue for good reason).

However, things can change, and a common thread among the participants in the discussion was the need for a new natural buyer of UK equities. Global investors won’t buy the UK just because these assets are cheap. They need crowding in. Gone are the days of the UK pension funds and insurance companies allocating significant proportions of their AUM to UK equities. The Edinburgh Reforms and Mansion House Compact offer hope that the upcoming Autumn Statement will offer new policies to improve the allocative efficiency of the UK markets.

If interest rates have peaked and we can get some politicians who can deliver some fiscal restraint, then global dollar liquidity can flow again as economic growth recovers. The UK is primed for more than its fair share, as defined by its measly 4% MSCI Developed World Index weighting. We might not be there yet, but the map is indicating the right path to take. As Laurence said, whether it is six months, three years or five years, if you are a patient investor, mean reversion will provide a useful tailwind.




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