As inflation weakens and double digit inflation numbers across the world fade away, stock markets seem to have rebounded. In reality the Fed has continued to emphasize on the importance of interest rate hikes as core inflation remains sticky. This is not in line with market expectations that currently are pricing in potential interest rate reductions by the central bank in response to weakening demand (Figure 1). The central bank seems to rely its current strategy on stronger than expected labor market pay-roll statistics and stabilizing unemployment rate rises. Despite the strong job market, a new risk emerges in which consumer spending distribution shifts and non-essential spending in leisure and appliances gets hit.
Consumer Spending Heavily Impacted
As the effect of persisting inflation is continuing to undermine consumer spending as disposable incomes are affected heavily. While interest rate hikes are necessary to cut inflation, the higher rates cut heavily into mortgage owners who have to re-finance debts against significantly more disadvantaged rates. Longer lasting inflation will lead to change in consumer behavior as consumer sentiment is at multi-year lows despite recent soft recovery (Figure 2). However, despite these risks and stagnating growth there seems to be little signs for a major recession in the near future but this could change as interest rates rise, inflation persists and consumer sentiment remains pessimistic.
Major Risk Ahead: Lower Margins And New Bank Failures
The current hawkish attitude of central banks could become an increasingly large burden for companies with much long term liabilities that need refinancing. While the impact of less venture capital seems to have little impact on the job market, rising rates could disincentivize structural investments in research and development by corporations as the risk-free rate rises. At the same time interest burdens could impact margins and lead to slower growth and employment cuts as big-tech continues to lay-off workers.
Secondly, rising interest rates might trigger additional bank failures and could cause lending caution and thus credit drought which has negative spillover effects all over the economy as financing is a corner stone of the economy. The potentially upcoming correction in markets could pose a possibility for investors to dive into structurally under-supplied markets like the copper and rare-earth market that have performed significantly well the last couple of years.
At the same time it might be an opportunity to lock-in long term bonds at high interest rates now inflation seems to be falling. The only risks being inflation rising again which will cause bond prices to fall. Current market indicators show stabilizing uncertainty but it can change quickly in the case of another bank failures. Also, the previous month the ETF volume dropped to 2020 lows as investors remained cautious for new inflation numbers and more hedge funds are shifting to short positions.
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