During the month of August and highlighted by the lack of liquidity, we witnessed a rebound in long terms around the world, due mainly to the possible end of the NIRP in Japan and above all to doubts about the continuation of US deficit ($2.2trn per year approximately, taking interest into account), and where real interest rates (once inflation is deducted) are close to 2%.
It has again mobilized the cautious bonds, as we warned at the beginning of the year, looking for a solution to the dynamics of the spending of the US Government, whose debt, close to 130% of GDP, exceeded the level of reached after the Second World War. Unlike in the past, this spending time is difficult to cut for any administration seeking access to the White House. A snip in the main things (Social Security, Health and Military) is not well received, because of the strong social and strategic components. The problem is highlighted by having financing costs higher than the rate of economic growth, which introduces the economy to the so-called debt trap.
And despite what the exponents of Modern Monetary Theory proclaim, the issuance of debt in the currency itself, to fight against inequality and economic stagnation, cannot be eternal. In fact, with the capacity to issue debt in a more embedded way and a Central Bank that can help finance it, it should balance the public deficit in a sustainable way, reducing the level of spending and increasing collection capacity. Measures that will undoubtedly negatively affect economic growth and further reduce possible inflationary pressure. The latest example of the dangers derived from moving away from orthodox policies was experienced last year in the United Kingdom.
The current market narrative discounts the return to a “Goldilocks” economy. In finance and economics, the term “Goldilocks” refers to an economy that is neither too hot nor too cold (in reference to the story of “Goldilocks and the Three Bears”). In this context, “too hot” refers to an economy that is growing too fast, which can lead to inflation, while “too cold” refers to an economy that is not growing enough, which can lead to unemployment. and recession. A “Goldilocks” economic scenario, therefore, is one in which the economy experiences stable and sustained growth, with controlled inflation and low unemployment. It is a term used to describe an ideal economic balance where the conditions are reasonable: neither too expansive nor too restrictive. In this environment, both risky assets (stocks and/or credit) and bonds tend to perform well.
From a risk management point of view, and after the significant improvement in fixed income and variable income assets from the October 2022 lows, where inflation has slowed down significantly and where the expected discounts in an economy that able to avoid a recession, a deterioration of the narrative around The budget deficit in the latter part of the year may mean, like the spending ceiling, a period of volatility that is not currently seen in financial valuations that market. And a disagreement on budgets, due to the high financial needs of the US government, is more likely to create a deterioration in the long term, with a consequent negative impact on risk assets. Along with this, we must consider four variables that can affect the purchasing power of the American consumer:
-The increase in the price of fuel, due to the arrival of winter and the depletion of strategic reserves in America, will increase the price of energy again, which will negatively affect the readings of inflation.
-The termination of student loan payments, which affects 40 million people with an average payment of approximately $400 / month.
-The depletion of excess savings generated during the pandemic, by a consumer who increases his level of spending, while at the same time losing the capacity to earn.
-The tax delay due to the pandemic, in states like California, is about to end, and this year, in 6 months, the consumer must pay 2 years of taxes.
With equity markets with returns of more than +15% so far this year, and fixed income markets, against all odds, starting to lose, we are entering the final part of the year where there lots of uncertainty for the bottoms. volatility in the markets. That’s why we again recommend increasing liquidity buffers and reducing durations, facing the end of the year.