The era of easy money looks to be over. With that the bull-run witnessed in the global markets also seems to fade away. How far will inflation rise and will the central banks around the world be able to tame it remains to be seen. Rising yields are an indication that interest rates at least in the near future will remain upbeat.
And, in turn, the high valuations till now enjoyed by companies will be coming down. In a recent report on global markets by Emkay Global Financial Services, this is echoed. “The US 10-year yield may peak at 3-3.5%, but a renewal of the bull-run in equities and credit markets looks unlikely. Historical precedent depicts that equities and credit struggle well after 10Y rates peak. We feel peak rates are just the prelude to the end of this short but explosive business cycle.”
The report adds – In the near term, or at least 1HCY22 may still sail through with a narrative of above-trend growth globally, barring the likes of China, Russia, etc. — This is also being helped by upside surprises on (US) earnings, albeit will still see multiple compression due to higher rates. On the other hand, CY23 will ring in more noises of a recession and major reassessment on asset rotation, as weaker growth and earnings will likely replace higher interest rates as the dominant drivers for risky markets.
The risk of the US economy slipping into recession is also underway. However, there have been such scenarios in the past as well. Here is what the report says about US recessionary fears.
If we look at the 2000-01 and 2006-08 cycles, and to a lesser extent the 2018-20 cycle, we find that 10Y rates peaked about a year before the recession started. Interestingly, all these years were also a confluence case of high valuations/asset bubbles, along with Fed tightening.
In fact, in the 2000-01 cycle, 10Y rates even peaked about a year before the Fed stopped tightening. Equities and credit delivered an occasional bear market rally but eventually succumbed to recession.
While it is anyone’s guess if the US recession in the next 1-1.5 years is impending, but, absent a miraculous supply side response globally, it is tough to see how a peak in 10Y rates this year between 3-3.5% heralds the start of a soft landing (a la 1995) and a new bull run for risk markets. More likely, peak rates are just the prelude to the end of this short but explosive business cycle.