This commentary was posted recently by fund managers, research firms and market bulletin writers and was edited by Barron’s.
Animal spirits decline
April 8: The Animal Spirits Index (ASI) slipped deeper into negative territory in March, falling to -0.24 from -0.22 in February. At the basic level, an ASI value above zero indicates optimism, while a value below zero suggests pessimism. The index consists of five indicators: the
the Conference Board’s consumer confidence index, the yield spread (between 10-year and 3-month Treasury bills), the
the Economic Policy Uncertainty Index and the Economic Policy Uncertainty Index. The Political Uncertainty Index was the sole driver of the ASI’s overall decline in March, jumping 60.6 points.
The index also lost momentum on a quarterly basis, signaling caution as economic agents are nervous about the current state of the economy. The ASI fell to -0.19 in Q1 2022 from +0.08 in Q4 2021, the weakest quarterly average since the first three months of 2021. The slowdown suggests confidence in the ongoing recovery started to fade, which is in line with our lower than expected GDP of 0.6% for the first quarter of 2022.
Eventually, the ASI could continue its downward trend in the coming months. Soaring inflation, rising oil prices and an inverted yield curve have sparked talk of recession. We believe there is a 30% chance that the US economy will contract at some point by the end of 2023, which could further dampen economic sentiment.
A more aggressive tone from the FOMC to contain inflation has led us to anticipate further policy tightening, and we expect the fed funds rate to peak at 3.00%-3.25% in the second quarter of 2023. Rising inflation is also eating away at previously enacted budgets, and state and local government hiring has been slower than expected. All of this has added uncertainty to the trajectory of economic policy and increased the potential for market volatility.
—Azhar Iqbal, Nicole Cervi
China takes notes on sanctions
April 8: Western sanctions against Russia following its invasion of Ukraine have essentially frozen much of the country’s foreign exchange reserves. Last month, Russian Finance Minister Anton Siluanov revealed that around $300 billion of the country’s $640 billion in foreign exchange reserves are affected by these sanctions. This will end up hampering the ability of Russian policymakers to support the national economy.
This event serves as a wake-up call to China, which is engaged in a strategic geopolitical rivalry with US Western sanctions against Russia, ultimately demonstrating the impact of economic warfare against Western allies. This will likely speed up Beijing’s efforts to shield itself from potential Western sanctions in the future.
A likely implication is a reduced willingness on China’s part to hold foreign exchange reserves in US dollars. Chinese efforts to diversify reserves are unlikely to result in an immediate aggressive sell-off of current US dollar-denominated holdings. Instead, it will be a long-term process by which China reduces its allocation to these financial assets by stopping its accumulation of these assets.
Given that China is running a large current account surplus, the question then becomes, how will China allocate these funds? Accumulating more European or Japanese assets will expose China to the same economic risks as US dollar assets, and are therefore not options. Thus, China could instead increase its purchases of real assets in other emerging markets. This outward acquisition strategy will also be part of China’s efforts to expand its sphere of influence and give Beijing greater control over these assets. This process will benefit currencies from emerging economies which will be subject to Chinese buying and, at the margin, will be negative for USD/CNY and US Treasuries.
Public services on the verge of collapse
April 6: Bonds had a disastrous start to the year, with the 10-year US Treasury yield falling from around 1.50% to a high of 2.65% today. Despite this decision, the secular downward trend in yields over the past 40 years remains intact, according to our work. Large speculators are the sharpest 10-year Treasury futures (relative to open interest) since the fall of 2018. This is often a contrarian signal preceding lower yields. While there may be a bit more upside towards 2.75%, we believe we are close to a tactical top in yields.
Conversely, utilities are the second best performing sector since the start of the year (+7.44%) and the best over the past month. They are also at secular resistance, and about as wide at their 200-day moving average as they have been over the past two decades. While bonds and utilities have tended to be positively correlated over the past few years, this year that has reversed. We believe there is a reversal pattern where bonds should rebound and utilities should pull back in the near term.
Salute to American Innovation
genetically modified organism
April 4: To succeed [in decarbonizing the global economy] we need to place increasing value on new ideas and new research. The United States does this very well in its venture capital activity and its large research universities (which are the envy of the world). The United States may have slipped in some trade areas, but in these it is truly exceptional, the biggest and the best. But the collective scale is still far too small, as business and government R&D has for several decades been shrinking rather than growing. Our best asset for long-term sustainability, and even prosperity, is for government, business, and individuals to support all of these unique strengths of the United States: research, innovation, commercialization, and the unusual will of our society. to take risks (also a widely admired American characteristic). Our collective survival as a reasonably stable and livable global society may depend on American leadership in all of these areas. As we enter the new age of environmental damage, scarcity, and physical limitations, we’re going to need all the innovation and ingenuity we can muster.
2.5% yield: unchopped liver
Center Street Cambridge Corporation
April 4: No one can say for sure whether a new long-term interest rate cycle mirroring the one most market participants have experienced is correct; Only time will tell. Our mission is to protect capital, whatever the future. In that sense, examining the two-year treasury bill presents an intriguing picture. At 2.5%, its yield remains well below both its near 10% 30-year peak and its long-term average in the 4% to 5% range. Nevertheless, it is much more attractive as a potential investment than the 0.15% it offered just a year ago, or the short-term bills currently yielding 1% or less. Irrespective of the direction of rates, it could be justified to tie up capital for two years without credit risk and with little price risk for a return that is a multiple of that currently obtained with money market funds, in especially in such a volatile and uncertain environment like the one we face today. Far be it from us to voice our enthusiasm for a 2.5% return, but investors may finally have the option of getting paid to put funds somewhere safe until something better happens. present.
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