Rubrics Asset Management Fixed Income Macro View: How Financial Markets Reflect the Collective Global Emotional State
Financial market activity can often be seen to reflect the collective global emotional state. Research from Rubrics Asset Management shows that the bond market most typically represents this emotion.
Bond markets react to the emotional state of the world’s population, with yields soaring at times of optimism. This could be seen in early 2016 when, prior to the election of Donald Trump in the US, the outlook was rosy and full of the prospect of fiscal stimulus, leading to positive impacts on inflation and growth.
Today, when we see a much more negative and fearful outlook, there are around $17 trillion in bonds with negative yields, representing fear across all markets from high yield debt to government. The bond market is reacting to a global fear, which reaches into almost every corner of the world – fear of market illiquidity, fear of escalating trade wars and more.
Bond yields have stabilised to approximately the same level as early 2016, but the driving force is no longer optimism but fear.
Reactive not Proactive
The fear that has been experienced over the past few years has led to a cycle of reactive rather than proactive behaviours. Decision-making processes at the highest levels have been forced to react to crises in markets and economies, rather than implementing proactive strategies and policies that can be built upon sustainably for future growth.
The solution to each problem and challenge that has occurred in recent years has been to incur more debt, a solution that acts only as a temporary sticking plaster applied at the expense of future growth.
Rubrics Asset Management suggests that while there have been opportunities for recalibration of the global economy, the rise of populism has meant that political leaders have simply not had the stomach for it.
US / China Trade War
One of the major contributing factors to the current state of the global markets and the collapse of global rates has been the trade war occurring between Trump’s United States and China. The rallying of the bond market can be seen as a direct reaction to the imposition of 10% in duties applies by Trump to more than $300 billion in value of imports from China.
When China retaliated by devaluing the Yuan, the markets became even more spooked. As things stand at the moment, the dominant emotion regarding the trade war is confusion. Nobody seems to know what the US actually wants to achieve from the current stand-off, least of all Trump, leading to confusion within the White House that has repercussions throughout the global economy.
Bond Market Challenges
Global growth expectations have been declining since Q1 2018, with global inflation expectations also declining since Q4 2018. Thin liquidity in August combined with Trump’s tweets led to a pick-up in volatility in the bond market. Rates are now in negative territory and, more worryingly, the central banks do not have enough tools for a fair fight against the downturn. Interest rates across the markets have reached historic lows, while inflation rates in most countries are far from negative. The labour and services markets have picked up, although manufacturing has long been looking dismal.
Bond Market Behaviour
The current state of the bond market points to a possible deflationary recession in the very near future. Analysis from Rubrics Asset Management, however, shows that this is not definite. There are in fact several key indicators gathered from economic data that highlight the possibility of continued strength within the bond markets, at least when looking outside of PMIs in the manufacturing sector.
The move in rates has not yet been confirmed in other markets, with no current suggestions of impending disaster in either the foreign exchange markets or the price of oil. These two markets often act as key indicators of the state of the global economy and they are not currently under any stress.
Global growth will likely continue for some time to move at a significantly lower level and it is possible the situation could deteriorate further. However, Rubrics Asset Management suggests that the outlook could be more positive than the current state of the bond market indicates, and we may not yet have reached the end of days scenario suggested by the huge amount of negative yields.