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Traders feel the pressure on the floor of the New York Stock Exchange on September 13. Photo: Reuters
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

Global recession fears and collapse in confidence could turn the dash for cash into a stampede

  • Investors are running for cover as recession beckons, inflation and interest rates rise and global economic confidence withers
  • Despite many turning to the US dollar as a safe haven, the continued rise in interest rates suggests cash will soon be king
The world is no picture of health at the moment, and it’s no surprise that investors are running for cover from stocks, bonds and peripheral currencies. Recession is beckoning, inflation and interest rates are heading higher and global economic confidence is ebbing away.
With whispers of nuclear sabre-rattling emerging from Russia over the Ukraine crisis, it is no wonder that global financial stability is suffering and markets are flinching. Investors can hardly be blamed for thinking the world might be entering a new phase of upheaval on a par with the 2008 global financial crash.

They have limited options for sanctuary and, not surprisingly, many are turning to the US dollar. As global interest rates continue to rise, though, there is a growing feeling that cash is king.

With so much global dislocation in evidence, the threat of a major credit crisis is increasing quickly. Borrowing costs are on the rise, global trading conditions are under duress and rising fuel prices are pushing energy-dependent, highly indebted nations’ balance of payments even deeper into the red. All this signals a major debt default could be on the cards.

World financial conditions are still recovering from 2008, and the Covid-19 crisis has left global policy reserves severely depleted. Economic confidence has almost become impervious to low interest rates and the easy availability of credit, while government budgets and debt piles have ballooned after years of fiscal reflation efforts. The cupboard of global policy options looks worryingly bare.

Hong Kong consumers to face higher cost to borrow after US interest rate rise

Global bond yields are only just starting to react to all the nascent risks and could have a lot higher to go. The close-to-40-year bull market for US bonds came to an end in August 2020 at the height of the pandemic, when 10-year US Treasury yields hit a historic low of 0.5 per cent.

With 10-year yields already clawing their way back to 3.7 per cent, it is only a matter of time before Treasury yields move back to their pre-2008 crash levels above 5 per cent.

Longer term, it is pure conjecture about how far the bear market for bonds extends and how much 10-year Treasury yields move back towards the historic high of close to 16 per cent in September 1981, when aggressively tighter US monetary policy was really starting to inflict a lot more damage on bond market sentiment.

How high US bond yields climb will be determined by the Federal Reserve’s response to inflation risks in the coming months. This really depends on how hard the Fed is prepared to press to get US core inflation, currently around 6 per cent, back down to its 2 per cent target.
If the US central bank pushes much beyond the projected central tendency for Fed funds to hit 4.6 per cent in the next few years, the impact on US bond yields could be dramatic at a time when the Fed is unwinding its quantitative easing programme, reducing its balance sheet and selling its hoard of purchased bonds back into the market. The US bond market could go into a state of toxic shock.
The impact of higher US bond yields will send major shock waves across asset markets globally. Borrowing costs will rise, credit spreads will widen and risk aversion will kick in hard, especially for peripheral bond markets.

At the moment, market fear gauges, such as the CBOE VIX volatility index and low-grade US corporate bond spreads, are elevated but not showing clear-cut signs of imminent disaster – yet. But history shows that, when the chips are down and investors are panicking, the tide turns very quickly.

Central banks must be proactive on inflation, but not overreact

The 1997 Asian financial crisis, the 2008 global crash and the 2010 European debt crisis underline that market confidence can collapse with catastrophic results, and it could easily happen again. There are clear signs that global confidence is already wobbling.
Currency markets are under strain, with the euro recently breaking below parity against the US dollar and political uncertainty in Italy back in focus. Meanwhile, the British pound is in crisis over unsustainable fiscal policies. Sovereign credit spreads are widening, with investors on amber alert.

With risk aversion rising, the investor dash to cash could turn into a stampede.

David Brown is the chief executive of New View Economics

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