October 19, 2021
Liquidity is a key component in and predictor of the financial and economic cycles that cause asset price swings, movements in interest rates and changes in business activity. Global liquidity peaked in late 2020, saw a slight spike higher in September with the IMF’s special allocation of new SDRs, which caused around a 2.5% jump, but has now resumed its downtrend.
This drop warns of gathering storms for 2022, and while not actively bearish yet, combined with the downturn in world business confidence this is not especially bullish for traditional asset markets.
If we combine this with the current higher inflation prints and consider Central Banks could be tightening policy soon, for example the Bank of England where expectations for hikes have been heavily priced in: the December 22 Short Sterling contract having having repriced all the “Covid Cuts” out of the market in what have been exceptional moves particularly since Governor Bailey’s recent speech. Meanwhile over at the ECB, they are already warning that “the exit from QE will be bumpy”, yet investors are still heavily exposed to Eurozone stocks when perhaps it would make sense to be in more defensive positioning? The results season in the US has been going pretty well so far.
That said, globally, investors’ risk exposure is pretty much in the middle of its normal range, so there is room for all assets to appreciate further in the future once the reduction in liquidity has been absorbed.
So what are the bond markets telling us? Well perhaps we should start with what are bond markets supposed to tell us? Usually, two things:
1. Investors inflation expectations (taken from break-evens)
2. likelihood of a future recession (from the slope of the curve)
But as usual, it’s way more complex than that, primarily due to the massive injections of Central Bank capital holding yields down across the curve but specifically in the longer ends. It is still interesting to note that the bond curve in the UK was managing to steepen until the recent front-end sell-off sent it back to its annual lows. With 5y5y inflation expectations in the US back north of 2%, the old bond trader in me would be looking to sell the belly of government curves here.
Household deleveraging is continuing across the globe, but global growth can only continue if consumers are confident in their prospects. Hence employment and savings rates should be carefully monitored, especially if there is wavering economic sentiment and a difficult winter ahead. Boosts from infrastructure spending make much sense here: interest rates for governments to borrow at are historically low, and private savings levels are high. Clearly, for a sustained recovery, though, we will need to see businesses focusing on capital expenditure (CAPEX), indicating they are confident about the future.
This is very much what we see here at Pactum: businesses keen to achieve growth in new markets or by acquiring weakened competitors all via working capital solutions. Meanwhile, investors look for alternatives to bonds and stocks and to gain exposure to the working capital arena that offers stable returns on highly diversified risk.
Our own receivable-backed fund is on target to achieve it’s 3% return (Euro class) for 2021 with extremely low volatility of the monthly returns: i.e. fulfilling the fixed-income replacement role it is designed for near perfectly.
Text written by: Rick Pearson, Chief Investment Officer, Pactum AG