We have repeatedly mentioned in our weekly posts that the resilience of the stock and bond markets over the last several months has actually been quite impressive. Interest rate hikes by the Federal Reserve have completely changed the financial landscape when comparing to the entire post 2008-09 world.  Most financial writers did not predict that a return to the world where a 4% savings account was even possible – ever – but here we are. As for now, the world seems to be ignoring the fact that several hundred trillion dollars of debt (the world’s total debt is about 350% of world GDP) is going to have to be serviced and continually higher interest rates. As daunting as those numbers seem, for now the proverbial ship is still in the water for the world economy. The negativity from financial pundits is still relatively high – causing traders to short sell and the result is that days such as last Friday pop up when many of the short sellers have to cover their positions and buy back. That is the good news…

The bad news is that we are still amid a wild financial experiment that the world has never seen on this scale before. The world’s central banks poured more than $10 trillion of “liquidity” on to our financial system after the March 2020 panic. Then starting about a year ago, the same central banks pulled the rug so-to-speak out from under the financial markets and economy. They tightened credit markets with higher interest rates, soaking back up some of that “liquidity.” Some financial numbers have remained remarkably robust – such as the employment figures. Other indicators of the health of the economy look pretty bad including Purchasing Managers Indexes, capacity utilization numbers and of course, pretty much every residential real estate statistic…

But that may be some of the “noise” of financial markets or the economy. One of the really bad economic indicators when you are looking from 20,000 feet is the yield curve.  Take a look at a picture of the last forty years of the “yield curve.” This is the 10-year U.S. treasury yield minus the two-year. When the yield curve inverts – at least in this timeframe – a recession ensues. Take a look…

As you can see the yield curve is inverted right now – and more so than it has been since all the way back in the early 1980s when Fed Chairmen Paul Volcker took interest rates toward the moon to fight off the raging inflation of the time. Understand that a 2-year interest rate that is higher than a 10-year interest rate is indicative of an investment marketplace that isn’t keen on taking long term risk. Historically, the inverted yield curve is a very accurate predictor of recessions. On the surface it would appear that the interest rate markets believe that there is quite a recession on the horizon.  The yield curve is steep and getting steeper – and the Fed will be raising short term interest rates into this inversion later this month.

If looking at some of the already bad economic numbers and the historical predictor of an inversion of the yield curve shows such obvious picture of an economic drawdown, then how are things holding together? At least part of the answer to that question is our Trillion Dollar Secret. The world’s central bankers are advertising that they are tightening monetary conditions, yet according to Matt King, a strategist with Citigroup a net $1 trillion in new liquidity has been injected into the world’s financial markets. This net positive is largely due to the Bank of China IN THE LAST MONTH! The liquidity provided by the BOC was a major driving force of the world’s markets after the 2008-09 meltdown and they are trying to rerun that strategy. Some economic indicators in China are revitalizing a bit – which is likely the result of this stimulus. Some of this is obviously flowing through to the rest of the world’s economy which, thus far with rising interest rates is surprisingly resilient.

The stark reality is that our economies and financial markets are overly dependent on the actions of the world’s central banks. Obviously, that won’t be changing any time soon – but we know what we are up against and continue to read the tea leaves. So, stay tuned…

Regards and good investing,

Greyson Geiler