The Bear Market Is Here, What Next? | Joseph Wang & Alfonso Peccatiello
Jun 13, 2022
46:53
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Quick takeaways
Market volatility is driven by rising inflation expectations, tightening financial conditions, and the potential for the Federal Reserve to hike rates above the neutral level.
The reliability of the yield curve as an indicator of recessions has been diminished by structural changes in the market, but if the Federal Reserve tightens policy above the neutral rate, the curve could invert significantly.
Deep dives
Margin Cold Days and the Underlying Reasons for the Sell-off
The podcast episode discusses the concept of margin cold days, where leveraged investors face significant drawdowns and margin calls. However, the sell-off has been ongoing for several months due to macroeconomic reasons. The declining stock and bond markets are attributed to rising inflation expectations, tightening financial conditions, and the need for the Federal Reserve to potentially hike rates above the neutral level. This has created a challenging environment for investors, particularly in Europe, where the situation is even more complex.
Inverting Yield Curve and Bond Market Outlook
The yield curve is analyzed, with the podcast guests noting that while historically it has been a reliable indicator of recessions, recent structural changes in the market have diminished its significance. Factors such as government involvement, regulatory requirements, and distortion from private investors have impacted the curve's accuracy. However, they acknowledge that if the Federal Reserve tightens policy above the neutral rate for an extended period, the curve could invert significantly. The guests also discuss the potential impact on borrowing costs, bond market dynamics, and the influence of the Federal Reserve's guidance on market expectations.
Federal Reserve Decision and Market Expectations
The podcast anticipates the Federal Reserve's decision at an upcoming meeting, with market expectations initially at 50 basis points hike. However, some strategists have speculated on the possibility of 75 basis points or even 100 basis points hike. The guests believe these scenarios are unlikely, but emphasize that forward guidance and the Fed's projection of the neutral rate will be key. They discuss the Fed's potential communication strategies to steer market expectations, including signaling a higher neutral rate, a more aggressive path of rate hikes, or a suggestion of going above neutral to address inflation concerns.
Implications for Bond Market and Economic Outlook
The podcast concludes with a discussion on the implications for the bond market and the overall economic outlook. The guests note that the bond market has been influencing the Federal Reserve's decisions, as well as vice versa. Factors such as steepening the yield curve, potential inversions, and the need for a higher terminal rate are considered. They anticipate that the Federal Reserve's actions will impact borrowing costs, credit spreads, and overall market dynamics. The podcast highlights the current uncertainty in markets and encourages listeners to stay updated on future developments.
With stocks, crypto, bonds, gold, and commodities tanking, Jack calls an emergency podcast and asks trusted Forward Guidance regulars, Joseph Wang and Alfonso Peccatiello, to put the ongoing market volatility in the context of runaway inflation and central bank tightening. Filmed live on June 13, 2022.
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Joseph's latest piece, "Turbo Tightening," can be found here: https://fedguy.com/turbo-tightening/
Alf’s latest piece, “The True Reason Why Central Banks Do QE,” can be found here: https://themacrocompass.substack.com/p/portfolio-rebalancing-qe?s=r#details
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