While interest rates are pivotal in determining equity valuations, it's essential to juxtapose them with the trajectory of earnings growth. The coexistence of surging Treasury rates and persistent buoyancy in the equity markets can be attributed to augmented earnings forecasts. In this light, the resilience of equities seems well-founded and will likely endure as long as the anticipated growth justifies the premiums.
Intriguingly, despite the Federal Reserve's benchmark rate standing at 5%—suggesting their capability to rein in inflation to a target of 2%—the prevailing scenario where banks are flush with reserves prompts a glance at the Federal Funds proxy rate. Positioned at 7%, it intimates that actual rates might be on an even steeper incline, hinting at more pronounced economic repercussions on the horizon.
The Bank of Canada maintained a steady rate of 5%, signaling potential future tightening. And while much discourse revolves around U.S. debt fluctuations, Canadian debt exhibits greater volatility, primarily attributed to their aggressive Treasury fundraising initiatives.
The U.S. economy displays commendable resilience, underscored by robust nonfarm payroll statistics, an unexpectedly upbeat consumer sentiment, and an unemployment rate plummeting to a decade-low at 3.8%. Additionally, retail sales figures surpassed anticipations by a considerable margin, with building orders following suit.
Regional Banking Crisis: We can anticipate significant consolidation among smaller banking entities, especially considering the prevalent asset-liability mismatches and portfolios laden with long-duration assets that have significantly depreciated through the rate-hike phase. Intriguingly, this phenomenon seems to be absent in Emerging Markets, where easing cycles are bolstering already robust bank balance sheets.
Presently, monetary and fiscal policies seem to be pulling in divergent directions. While the Federal Reserve aims to temper economic fervor, the Treasury is accumulating further debt to address imminent matured obligations. This has led to a surge in the fiscal deficit, now standing at 2 trillion. A significant contributor to this chasm is the reduced remittances from the Federal Reserve, compelled to honor interest commitments to commercial banks for reserves held.
The impending trajectory for credit?
a. Soft Landing: Between 2010 and 2022, central banks actively orchestrated the balance sheets of financial institutions, which inherently capped potential losses or constriction. However, the current mandate veers towards allowing market self-correction.
b. Higher for Longer: The amalgamation of a PMI that's trailing expectations, coupled with robust overall growth and labor market figures, augments the case for a protracted elevated rate.
8. Interesting Charts:
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