Source: CICC Strategy
Authors: Liu Gang, Li Hemin, Yang Xuanting
The risk events that the market is concerned about recently have their own sporadic and special characteristics when viewed in isolation, but the connection of multiple “individual cases” also shows a certain degree of inevitability. This “commonality” comes from rising financing costs in the aftermath of interest rate hikes that continue to squeeze growth, cash flow, and balance sheets.
1. Why is there always “trouble” in the later stages of interest rate hikes? Fewer “cheap money”; financing costsRFContinuously rising, squeezing, and even exceeding the return on investmentg
The continuous rise in financing costs has led to an inversion of the long and short term, and the inversion of financing costs and return on investment.This situation can be depicted from dimensions such as term spreads, GDP growth vs. investment-grade bond yields, S&P 500 ROIC vs. high-yield bond yields, and S&P 500 ROIC vs. high-yield bond yields.
Money supply and credit expansion have decelerated, and “cheap money” has declined.The austerity cycle was also accompanied by the central bank tightening its balance sheet (QT) and a decline in overall money supply and demand for credit expansion, which was reflected in M2, bank loans, and “cheap money” supply.
The above problems will occur in the later stages of every interest rate hike. It's just that the degree of process is different. Since interest rate hikes are more aggressive in this cycle, the tightening is also more drastic.
2. Is the crisis an inevitable product of late interest rate hikes? A decline in growth is likely to occur, or even lead to a recession; however, a liquidity shock or debt crisis is not inevitable
In the context of rising financing costs, declining growth is a probable outcome, but it does not always lead to a recession. If some unexpected large fluctuations are combined, the problem of insufficient short-term liquidity will occur due to increased asset correlation and volatility, which in turn will evolve into a liquidity shock. If there also happens to be serious leverage pressure, it will induce a debt crisis.
From income statements (declining growth or even recession), to cash flow statements (liquidity shocks), to balance sheets (debt crises), although the boundaries of these issues cannot be “clearly defined” in reality, understanding the underlying transmission mechanism also helps us understand the extent of impact and how policies are addressed.Looking at it now, due to more severe austerity, the resulting misalignment of deadlines, and greater pressure on growth and liquidity, thankfully, the leverage problem is not very serious.
3. Asset performance after interest rate hikes
The month before the last 2 interest rate hikes is selected as the starting point, and interest rate expectations (risk-neutral interest rate on 2-year treasury bonds) peak and fall back to the end point, defined as the “late period of interest rate hikes.”
In the later stages of interest rate hikes: commodities > bonds > stocks; the stock market fell and volatility rose; development was better than emerging ones; interest rates on US bonds peaked and fell, and credit spreads widened; crude oil rose, industrial metals and gold were poor, and the US dollar index strengthened.
Defining interest rate expectations from peaking to falling back to the beginning of interest rate cuts as the “interest rate cut expectations” stage;Expectations of interest rate cuts are heating up: stocks > debt > bulk; stock market rebounds, emerging recovery; interest rates on US bonds decline; gold recovers, and the dollar weakens.
Editor/Somer