The Covid-19 pandemic viciously accelerated the dangerous levering up of the global economy that unfolded during the 2008-09 financial crisis. Central banks printed ever more money and took policy rates close to the zero bound in all developed economies. The policy of near infinite liquidity provision and easing financial conditions at all costs has pushed global sovereign and investment-grade corporate yields to historical lows and forced investors to take positions in riskier assets.
As 2021 gets under way, the merciless march of lower yields has left yield-seeking investors sitting on a pile of low-yielding junk debt with terrible reward-to-risk profiles, as zombie corporates teeter on the brink of default, having only survived the pandemic months with handouts and the lower refinancing costs. The investors’ risky stance is justified by the prospect of an effective vaccine bringing a new boom in economic growth. But reality doesn’t prove so kind, as the vaccine roll-out and the removal of Covid-19 restrictions and normalisation leads to a sharp spike in inflation. In perfect hindsight it turns out the economy was vastly over-stimulated during the pandemic, and the ripping post-vaccine recovery rapidly overheats the economy. Inflation rises and unemployment falls so rapidly that the Fed allows long treasury yields to spike higher, taking the yield on riskier debt with it.
The Fed ends up making a policy mistake by allowing financial conditions to tighten too rapidly via higher longer rates, having never implemented yield curve control as they were too distracted by the sudden spectre of 4-5% annualised inflation and 6-8% annualised wage gains by Q3. Corporate defaults rise to their highest in years, with the first to go the most over-levered companies in the physical retail space that were already struggling in the solid, pre-Covid economy. For the first time in economic history, a strong recovery sees rising defaults.
Trade: Short HYG and JNK High Yield corporate ETFs
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Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.