Rising US interest rates, US$ and oil prices set to pressure financial markets

Uncategorized

SHARE THIS STORY

Everyone who has ever played the Beer Distribution Game on a training course knows what is happening in supply chains today. A small increase in underlying demand is rapidly leading to a massive increase in ‘apparent demand’.

As the New York Times reports,the pandemic has disrupted every stage of the (supply chain) journey.”  And so purchasing managers have been spooked by bottlenecks:

So they are now over-ordering everything in sight. And in turn, investors are assuming a turbo-charged recovery from the pandemic is already underway. Although

“Second order” disruption is now underway as interest rates start to soar, along with the value of the dollar. As the chart shows, the benchmark US 10-year rate has trebled in recent months from its all-time low of 0.5%, taking the value of the US$ higher as well.

RATES HAVE FOLLOWED THE “BOUNCING BALL” PRINCIPLE

The “tram-lines” in the second chart confirm that rates are simply repeating the patterns of the past 30 years. They tumble when the economy seems to be weakening. And then they rise when things seem to improve again. Essentially, they mimick a rubber ball bouncing down a staircase:

  • They bounce downwards to a new low, and then pause
  • They then bounce higher as lower rates stimulate new demand
  • But they never bounce back to the previous high
  • And their next bounce downwards always leads to a new low rate

After last year’s collapse, it is no surprise they are now bouncing higher again as the economy starts to reopen. And they could potentially double to 3% without breaking through the “tram-lines”. But even at today’s levels they will have a major impact on key areas of the economy.

Mortgage rates are rising, and will impact housing markets in the crucial spring selling season.

Similarly, higher rates are making auto loan defaults more likely. And OPEC+’s decision to squeeze the oil market will reduce consumer spending, as people are forced to cut back on the discretionary items that drive economic growth.

FINANCIAL MARKETS ARE AT MAJOR RISK

The key risk, however, is in financial markets. Investors now assume that central banks will never let markets fall. And so as the chart shows, they have borrowed a record $800bn in margin debt.

Unfortunately, they are only now starting to realise that Joe Biden, unlike his predecessors, is focused on jobs rather than stock markets. As a result, the Federal Reserve is now hoping to see higher rate and inflation as a sign of economic recovery. As the head of the Richmond Fed told the Wall Street Journal last week:

In fact, I would be disappointed if we didn’t see yields, you know, rise as the outlook improves,” Mr. Barkin said, noting that bond yields remain meaningfully lower than pre-pandemic levels.  Mr. Barkin also said he expects inflation to rise, but not to problematic levels, and that he isn’t worried that another round of fiscal aid will cause price pressure problems by overheating the economy.”

‘Bubble stocks’ such as Tesla are already feeling the pressure. It is down by a third since late January, as it has little chance of competing successfully with majors such as Ford, GM and VW, now these are focused on the Electric Vehicle market.

And the danger, as in all market downturns, is that the selling becomes self-fulfilling as realism returns. The key risk is focused on the likely response from the Exchange Traded Funds and high frequency traders who now dominate the major markets:

  • They are passive investors – buying when prices move higher, and selling when prices move lower
  • So when investors loaded up on margin, they all rushed to buy as well
  • And when margin calls force investors to sell in a hurry, they will rush to follow

The end result will be a bubble-free market, driven by earnings and analysis rather than momentum and stock-market cheerleaders. But it will likely take a few years to unwind the damage that has been done over the past 20 years.

PREVIOUS POST

Weak demand - and the illusion of a return to "normal"

28/02/2021

My new interview with Real Vision focuses on the major changes underway in the e...

Learn more
NEXT POST

China's dual circulation policy aims to reduce debt reliance

14/03/2021

Every now and then, people wake up to the fact that debt is only good news when ...

Learn more
More posts
Americans hunker down on spending as the pandemic’s impact continues
11/04/2021

US stock markets have been hitting new records recently, as investors swoon over the idea that the $...

Read
Smallpox was the first vaccination to change the world – now we have a new opportunity to improve our lives
03/04/2021

Chart 1: Increased life expectancy led to a dramatic increase in GDP/capita The pandemic has reminde...

Read
COP 26 set to accelerate development of the 15-minute city
28/03/2021

One of the good things to happen in the pandemic over the past year is that ‘cooking has becom...

Read
Circular economy set to replace today’s broken global supply chains
21/03/2021

The Great Freeze in Texas has confirmed once again the problems with today’s global supply cha...

Read
China’s dual circulation policy aims to reduce debt reliance
14/03/2021

Every now and then, people wake up to the fact that debt is only good news when it adds to growth. O...

Read
Weak demand – and the illusion of a return to “normal”
28/02/2021

My new interview with Real Vision focuses on the major changes underway in the economy. Our analysis...

Read
UK set to take hard line on EU trade under David Frost
21/02/2021

The Brexit debate has always been about politics, not economics.  So it was no surprise that Decemb...

Read
Iran highlights OPEC’s dilemma on output cuts
14/02/2021

Saying you “won’t do something” may stop you digging a bigger hole for yourself. B...

Read

Market Intelligence

ICIS provides market intelligence that help businesses in the energy, petrochemical and fertilizer industries.

Learn more

Analytics

Across the globe, ICIS consultants provide detailed analysis and forecasting for the petrochemical, energy and fertilizer markets.

Learn more

Specialist Services

Find out more about how our specialist consulting services, events, conferences and training courses can help your teams.

Learn more

ICIS Insight

From our news service to our thought-leadership content, ICIS experts bring you the latest news and insight, when you need it.

Learn more