Daily Commentary BY THE CURVE TEAM –

Asset Price Inflation & Compounding Rarely Co-exist Harmoniously

22nd October 2018

US interest rates have been on the normalisation path since 2015. In 2018, there have been two instances, which have rocked equity markets both in February and October.

On September 24, the yield on three-month US Treasury bills rose above the core US inflation rate for the first time in a decade. Global central banks have stoked asset price inflation via the Quantitative Easing experiment. The realities of higher interest rates are tightening financial conditions and drawing liquidity elsewhere. This is causing numerous financial shocks to reverberate around the system unmasking so many weak linkages.

In this latest episode, global equity markets have stumbled, strong ETF inflows have reversed, real property markets are withering from reduced liquidity and the fixed income earnings from interest rate products are proving to offer greater certainty for a larger chorus of investors. The bell-wether implosion is the Shanghai Composite Index. It is down 30% this year and a mammoth 50% since 2015. President Xi is vowing unwavering support for the private sector, which is telegraphing there is a really significant crisis of confidence throughout the Chinese economy.

Add to this, crippling debt levels both in the official banking system and in the shadow banking system, which are hampering fiscal strategies that would normally be enacted during an economic downturn. The path to interest rate normalisation has many more challenges to negotiate than many of us can foresee. The economic and political systems will have to face head on, all the uncertainties and issues the adjustment phase brings forth. This current phase seems to be less severe than the earlier one in February 2018. We will have to monitor it’s vital signs as we approach the next FED Reserve interest rate hike, on the cusp of the Christmas holiday period.

Peter Sheahan

Director - Institutional Markets