A just-published report provided a framework to determine the level at which DM interest rates could finally cause a global recession. The report identified some signposts to watch for along the way, and the relevant investment strategy during the endgame of the current tightening cycle.
MRB’s frameworks use a broad concept of the cost of capital, which includes both policy rates and bond yields. Given the solid growth in nominal GDP, the cost of capital that may finally begin to meaningfully curb economic activity in the U.S. and aggregate G7 is still decisively higher than current levels.
On this basis, policy rates are still not restrictive. Critically, we anticipate that recessionary forces will first develop in the “weak links”, which will have contagion onto the overall global economy, rather than being led by the relatively healthy U.S. and euro area consumer sectors. Investors need to monitor these weak links closely.
A pause in the underlying uptrend in yields could soon occur. However, the cycle is not over: as bond yields rise further into 2024, we will shift from being cyclically bond-bearish to adopting more of a tactical approach. Equity investors should also be tactical at this point of the investment cycle. Bet on heightened volatility, use pair trades to limit risk, and maintain a preference to stocks with valuation support and relative earnings power to offset a higher cost of capital. At some point, outright short equity exposure will be warranted, stay tuned.