House View: October 2023

October 10, 2023

No recession – yet

With three quarters of 2023 already passed, the macro-economic picture around the globe remains very heterogeneous. Eurozone annual GDP growth approaches the zero-line, and considering the weak purchasing manager index readings of late, chances are high that the whole currency bloc enters recession this year. Chinese growth, an important driver of global economic growth in the past three decades, underwhelms as well, owing to demographic and other structural factors such as an investment boom that has led to an outsized real estate sector compared to other parts of the economy. The US economy, however, has stubbornly kept a strong pace of growth throughout 2023, and has surprised many observers, among them the FOMC members, who had expected to see the US economy eking out a mere 0.5{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} growth rate in 2023.

Reasons for this positive surprise can be found in the labor market which has demonstrated an impressive resilience and strong signs of workers’ growing negotiation power. Wage growth remains high by historical standards, with skilled employees difficult to find. The highest labor market participation rate among the 25-54 years old cohort since 2002 may be considered a reflection of the demand overhang for labor in the US. The recent gain in job openings has nullified expectations of an orderly and steadfast path back to pre-Covid levels, underlining the strength of labour’s negotiation power which was further bolstered by the September job creation data that got published in early October.



Source: Bloomberg


Inflation to stay elevated

The longer that inflation remains elevated, the higher the risk that it becomes engrained in the expectations of economic agents. Labor demand will stay high compared to the past two decades thanks to reshoring of economic activity, i.e. bringing jobs back to the US that had been exported to emerging markets during the period of fervent globalization. Moreover, the disruptive effects of the Covid pandemic in 2020-22 will linger on for many quarters, as the understaffing that continues in certain sectors is a direct consequence of the blunt mass layoffs in the first half of 2020, that have made fired employees unwilling to return to their original jobs. Labor supply on the other hand remains constrained by demographic factors: the share of the above 65 years old in the general population has risen from 12.7{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} in 2008 to an estimated 18.2{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} at the end of this year. The peak in the proportion of those 65+ years old looking to work has seen a drop during the Covid pandemic and since only trended sideways at best – meaning that while the number of persons employed above the age of 65 is still rising, the share of the population working is trending down.


Source: Bloomberg


Energy prices rising again

The era of “immaculate disinflation” is probably behind us, especially as base effects had been an important driver of the slowdown in inflation rates over the past five quarters. It is instructive to see the high in the US headline inflation in June 2022 at 9.1{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} dropping to 3.0{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} in June 2023. In August, however, inflation re-accelerated to 3.7{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539}, putting into question an elegant landing towards the Fed’s 2{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} inflation goal.

Geopolitical forces are an important driver of oil prices, with co-operation between OPEC and Russia an important ingredient in keeping oil prices high. The Biden administration’s explicit dislike of fossil fuels means that the US shale oil industry will not produce the amounts necessary to compensate for the cuts by OPEC+. Moreover, the administration’s reduction in the strategic petroleum reserves (SPR) by a good third from October 2021 to October 2022, was not followed by a replenishing strategy, as the SPR dropped by another 6{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} in 2023, with its level currently standing only one percent above the low quoted in July of this year. With the recent strength in oil prices and ongoing demand growth from emerging markets, refilling the SPR appears a distant (and pricey) promise or else further price rises in crude oil must be braced for.

The flaring up of military escalation in Israel, driven by an unprecedented attack by Hamas, the ruling party in the Gaza Strip, exactly 50 years after the Yom Kippur war, has driven up oil prices. We take the view that the geopolitical premium on oil prices has just been significantly increased. While the medium-term consequences are hard to foresee, the détente between Israel and other important countries in the Middle East may come to a halt and potentially even be turned back.


Source: Bloomberg


European energy crisis this winter?

One more threat is looming. A year ago, there was much talk about an imminent energy crisis in Europe due to its dependency on Russian natural gas (and oil, to a lesser extent). Natural gas prices soared more than tenfold, only to come crashing down after it became clear that reduced demand was due to high prices, a warm winter in Europe, and a continuation of deliveries from Russia. Indeed Russia still represents more than 10{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of total natural gas imports into Europe. From a strategic viewpoint, a sudden discontinuation of Russian supplies at a time of need, e. g. before an extended period of cold weather in Western Europe, could potentially lead to another massive disruption forcing prices up further.

Higher rates start to bite

Job creation in the US continues to surprise positively, with the number of new jobs created regularly exceeding expectations by a margin – up until this summer. What is more, cyclical parts of the economy such as leisure & hospitality have started to see job growth rate slow by more than two thirds compared to last year, while the more stable areas such as education and health services continue to display above-average growth compared to the previous two decades.


Source: Bloomberg


Financial markets appear to price an increased probability of a downturn, considering the rise in credit spreads at the lower end of the credit quality spectrum. This yield premium relative to government bonds such as Treasuries comes on top of the recently higher Treasury yields. From the low some five months ago, the seven-year Treasury yield rose by more than 40{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} from 3.32{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} to 4.69{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539}. The resulting funding cost increase will bite into any company’s income statement, so there is the risk of a downward spiral, with credit quality deteriorating further, increasing spreads even more. For the time being, there will not be much refinancing thanks to many companies extending their debt during the years of extremely low interest rates in the wake of the pandemic. In 2025 however, a large maturity wall looms and the prospects of refinancing at much higher rates could throw their shadows into 2024, when a potential recession already looms.

Government finances in disarray

We count ourselves in the group that expects “something will break” after the severe rate hikes of the past 6 quarters in the US, but also in other economic regions such as the EU. The averted government shutdown in the US once again dragged an unsustainable construct into the daylight: about three quarters of the federal budget is mandatory spending that is tied to programs with sound legislative basis, for instance public pensions and healthcare. With the current demographic trends, mandatory spending will only grow.

To bring some perspective into the issue: in 1973, when federal spending made up 18{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of US GDP, mandatory spending was responsible for 40{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of total federal government expenditure (7{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of which was used for net interest payments). In 2023, it is estimated that federal spending makes up 24{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of GDP and that mandatory payments (63{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539}) and the net interest expense (10{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539}) together account for almost three quarters of total federal government spending.


Source: Bloomberg


In recent months, the weighted average coupon has started to rise, with the Treasury choosing to focus on the short end when issuing debt (typically 3-month bills), signified by an average time to maturity of outstanding Treasury debt having dropped by more than a year since 2021 to a good 9 years currently. Gone are the days when the Treasury could issue bonds with 20 years to maturity and a coupon of 1.125{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} as happened in 2020 – and we strongly doubt that these days will come back.

The problem is growing by the day, as the refinancing of maturing bonds means a steep rise in coupons going forward and hence interest costs to the federal government. Since 2000, the share of interest payments to GDP was roughly stable at between 2.2{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} and 2.9{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539}. A doubling of interest costs would mean that the mandatory part of the federal budget is to rise even further, squeezing the remainder of the budget, so-called discretionary spending, of which about half goes towards national defense. The related appropriations bills must be approved by Congress on an annual level. With the current compromise, a stopgap spending bill until November 17, legislators have another 6 weeks to find a compromise. With the ousting of the House Speaker McCarthy by 8 members of the Republican Party, precious time is being wasted, in which a new Speaker needs to be found, before a serious discussion about any compromise can be started.

US FEDERAL BUDGET BALANCE ({65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} OF GDP)

Source: Bloomberg


The odds look tilted towards a government shutdown taking place in November. Financial markets have woken up to this threat and have driven Treasury bond yields to levels unseen in 16 years, reflecting fears of a government debt crisis in some form or other. As the provider of the globally dominant currency, the US seemingly is immune against a payment crisis or a currency crisis more generally. However, budget deficits in the order of 7{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} of GDP have not happened in the past 50 years in the absence of recessions. Deficits usually rise steeply in a recession due to automatic stabilizers such as unemployment insurance as well as a reduction in government receipts through taxation – so the prospects are very grim and steep rise in US Treasury yields is more than warranted, in our view.

Strong US-Dollar

Despite the rather unpleasant state of US government finances, the greenback was able to gain versus many other currencies on the back of higher interest rate expectations thanks to “higher for longer” messaging on behalf of the Fed. With dollar sentiment already stretched on the side of optimism, we doubt whether a new multi-year bull trend is in the making for the US-dollar. For now, things look set in stone – however, looking back to the month of March, when a regional banking crisis flared up in the US and the Fed had to inject USD 400 bn in liquidity into the banking system within two weeks, things might quickly take a turn if “something breaks”.

Global real estate concerns

The structural change towards higher yields on a global scale could well take its toll on real estate markets. Steep interest rate increases have already led to a significant slowing of construction activities. In some countries, there is a structural lack of new homes relative to the population that has been growing for years. In some European countries, such as in Germany where a majority of the population rents, legal reforms led to a stronger protection of tenants including limiting rent increases. The resulting supply shortage was exacerbated by the migration wave that started around 2010 and has set a new high in 2022.


Source: Bloomberg


Structurally higher interest costs will limit the supply of new homes, driving up prices. The situation in commercial real estate (CRE, particularly office) in the US is difficult, with an estimated USD 900 bn of US CRE debt coming due this year and next, according to MSCI. This compares to total bank equity capital in the US of about USD 2.3tn. In the short term, we do not see a major issue stemming from the sector, however the USD 3tn in total CRE loans by the commercial banking sector in the US is a large chunk that could well bring major trouble to US banks.


Source: Bloomberg


The Fed will cave

The imbalances in the global economy are growing. The combination of steeply rising interest costs with weak government finances in many countries is a harbinger of severe stress in the financial system. Acting as if everything is fine may be a prudent advice for central bankers and treasury secretaries; however, there is a lot of stress evolving under the surface and, as experience has shown, there could soon be tremors going through the global financial system. It is our base case that inflation is likely to stay elevated throughout this decade. Short-term oriented rescue operations aimed at achieving price stability will likely be pushed into the background as both fiscal as well as monetary stimuli may again need to be employed by governments over the next few years.

Some “financial market fever curves” have already started to trigger alarms, namely implied volatility levels (basically the cost of insuring against adverse price movements) in the bond market, but also the insurance premia against defaults of US banks (“credit default swaps” or CDS). We are convinced that as soon as a fire breaks out (currently, there is only smoke to be smelled), central banks will have to come to the rescue by again offering staggering amounts of liquidity to the system unless it breaks.


Source: Bloomberg


Headwinds for equities

Persistently positively surprising macro-economic data out of the US has led to some rethinking about the expected monetary policy easing that is to come next year as can be read from futures prices. Hence the market’s expectations of where federal funds rates will be at the end of next year have changed rather starkly in the past four or five months: Since early May 2023, the December 2024 futures-implied fed funds rate has risen by more than two full percentage points. In addition, the latest yield surge on bond markets over time translates into higher interest costs, weighing on companies’ bottom line. Compared to Q4 of 2018 when the Fed’s stated hard stance, i. e. its conviction to monetary tightening took a significant, if temporary toll on equity markets, the average yield to maturity of US corporate bonds, lies almost 2 percentage points higher today, with an acceleration recently from about 5.60{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} in early September to above 6.20{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} today.

In the period starting in the aftermath of the Global Financial Crisis in 2008/09 throughout Covid, the low yield environment meant that stock valuations were driven higher to reflect the increased attractiveness of stocks vis-à-vis bonds. Furthermore, economic weakness led financial market participants to expect even lower yields which in turn drove valuations even higher, offsetting a weaker earnings outlook (that usually comes with economic weakness). Now markets have reached a point where valuations remain elevated, but the concurring tailwind from low yields has now changed into a headwind, not only for valuations, but also for margins. “Higher for longer” will weigh on sentiment for some time, and while we are convinced that ultimately, central banks will have to cut rates and provide liquidity to markets, they may be not jumping at the first signals, as only the threat of a major default derailing global financial stability will cause them to step in.



  • The final quarter of 2023 has started with financial market wobbles that may well turn into something more significant, considering the many headwinds that can be made out currently: persistent inflation with rising energy prices, political gridlock in the US with a discomforting outlook on the coming 6 weeks (with another shutdown looming), extended valuation levels plus short-term Treasury bills offering more than 5{65b79214172807242d5f8cbb54acc75262ef12d1d68a01b20791f3528a757539} p.a. which many investors may regards as an interesting alternative to equities.

  • The highest government bond yield in 16 years appears attractive, however we consider the risk/return associated with owning Treasuries as rather balanced for the time being. Short-term Treasuries appear more attractive, for they do not suffer from possible further yield rises.

  • The US-dollar is profiting currently from a risk-off mood in global financial markets, with the nominal interest rate levels quite attractive at first sight. In relative terms, there are better options, in our view, with emerging markets such as Brazil, Mexico, Indonesia leading the list of high positive real (inflation-adjusted) government bond yields, compared to many European government bond yields still deeply in the negative. The longer-term factors however play against a new mutli-year bull for the greenback, so the current strength may be considered an opportunity to lighten up on USD positions.

  • Should we come across a major crisis event, or, as we wrote above, that “something will break”, adding longer-term government bonds may be considered a short-term buying opportunity as we are convinced that central banks once again will have to embrace a “quantitative easing” program, driving down government bond yields.

  • Gold and silver have suffered from the recent rise in yields; however we are convinced that a new bull market is already in the making, with any crisis resolution measures by central banks triggering a stampede into the classic inflation hedges – as price stability will be considered less important than financial system stability and hence the structural drivers of inflation are likely to remain in place.

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