Ok, let’s think this through, ahead of the forecast we will publish the first full week of the New Year.
Central banks across the globe have dramatically expanded their respective balance sheets, with some nearing the size of their country’s annual GDP. When they bought the largely quality Bonds, initially at higher and higher prices (Quantitative Easing (QE) asset inflation), the sellers needed to reinvest or sit on cash.
The investors searched the seven seas for replacement investors and found a myriad of alternative bonds, stocks and hard assets, e.g., commodities or commercial real estate, etc., which central banks could not or would not buy. The hope of QE is that the quality assets taken out of the market lead the sellers to invest in riskier assets (risk on).
Here is the problem, whether it’s equity or debt, returns are expected, which must be supported by growth or income. Consider Amazon investors who are starting to question its “grow until Amazon controls the market everywhere and ignore profits” strategy. Companies can starve on the way to this banquet or live off their investors until the music stops.
The other problem is when the Fed deploys a full QE operation in the USA, home of the world’s reserve currency, yields start falling initially due to supply and demand, but then yields rise in hope that the “risk on” will generate GDP growth and hence inflation.
When the Fed is not in a full QE operation, like now, investors worry that the Fed, lender of last resort, cannot help investors, so investors reduce “risk on” investing. One major concern is: when investors decide to liquidate lower grade bonds given the lack of liquidity in the market today.
In the macro picture, GDP in many countries is sluggish and slowing. Some commodities are falling and so the businesses producing these commodities are seeing their margins squeezed. How will they repay their bonds or what happens when expected growth turns negative? What happens when investors do not like future scenarios? Timelines begin to shrink quickly. Liquidity looks timid and small.
These are the questions and concerns behind our upcoming forecast.
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