Oomph outweighs angst, pushing market rates up

Market rates peaked in March this year. At the time, there was what looked like a relentless rise in rates underway, only to be undercut by the sudden and unexpected implosion of Silicon Valley Bank (SVB), with echoes in Europe as Credit Suisse was forced into a merger. There have been ripples of concern since, but apart from another few manageable banking causalities in the US, there has been a calming of nerves. In fact, we managed to morph from a state of material concern for the system to one of outright 'risk-on'. The coincident rise in market rates is an outcome of this. Plus there's sticky inflation in both Europe and the US (and beyond), and in the US an economy that just won’t lie down. So where now?

On the one hand, forward-looking indicators are in a recessionary state, small bank vulnerabilities remain, and lending standards are tight. The eurozone has moved into a state of technical recession, and China is showing only a subdued reopening oomph. That, together with the cumulative effects of rate hikes already delivered, plus the negative real wage growth environment, should ultimately place material downward pressure on market rates as we progress through the second half of 2023. A peaking out for official rate hikes from both the Federal Reserve and the European Central Bank in the coming months would mark an important point in the cycle. From that point on, market rates should be on the decline, and yield curves should be in a dis-inversion mode.

But we are not at that point just yet. The latest US core PCE number at 4.9% reminds us that the US is still a "5% inflation economy". We think this will change (inflation will ease lower), but for now, it is what it is until dis-proven. In the eurozone, there has been a material easing in inflation rates, but the headline reading is still high, at 5.5%. UK inflation seems to have stopped falling, but it is still close to 9%, requiring the Bank of England to re-accelerate hikes. In the US, the latest consumer confidence number for June popped back out to 109.7 (versus 100 at neutral). All of this places upward pressure on market rates, and these factors are likely to sustain the upward pressure, at least for as long as an underlying oomph factor remains in play.