Inflation projections over the past two years have underestimated the scale of the beast, and central banks’ stiff policy tightening today is an attempt to regain some lost credibility, says State Street Corporation’s Michael Metcalfe.
“Understandably, investors don’t have much confidence in the forecasts. That’s why they’re neutrally positioned now. There’s a question about the competence of projections [by] the private sector and central banks.”
Metcalfe leads State Street Global Markets’ macro strategy team, focusing on how the behaviour of investors and online retailers can help with investment decisions. “Our premise is that looking at the behaviour of investors is helpful when thinking about investment decisions. Knowing how investors are positioned and which assets they currently prefer is typically very informative of where asset markets will go in the future.”
Aside from investor behaviour, Metcalfe’s team also aggregates news headlines.
The media is talking an awful lot about inflation. But at the same time, it’s also talking a lot about recession, highlighting how we’re facing a stagflationary environment. Here’s a curious thing: The current media intensity on the term ‘recession’ is higher today than it was during the actual recession in 2008.
Is the worst over for the financial markets? Metcalfe does not think so. “If you look at how bad financial market returns have been this year, you might assume that investors are already very defensive and underweight. Unfortunately, while investors have increased their cash holdings so far this year, the level of cash holdings is only around its historical average.”
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In other words, “we haven’t had a capitulation”, he says. “Investors are only neutral on their cash holdings. They can increase their cash holdings further and withdraw more money from the financial markets.”
On Oct 11, the International Monetary Fund (IMF) said the global economy is staring at a worsening outlook, with a 25% probability that global GDP growth will slow to less than 2%.
Efforts to manage the highest inflation in decades may add to the damage from the war in Ukraine, along with China’s slowdown, notes the IMF, as it cuts its forecast for global growth next year to 2.7%, from 2.9% in July and 3.8% in January.
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A more stable future for Bitcoin?
Speaking to The Edge Singapore ahead of State Street Live, a forum featuring American financial services company speakers held on Oct 12, Metcalfe says the investment world learned “an awful lot” from the collapse of cryptocurrencies. “In particular, we learned what Bitcoin is and isn’t.”
There was an assumption years ago that the bigger Bitcoin got, the more stable it would become. “That isn’t going to happen; Bitcoin is already huge and incredibly volatile,” he continues.
From starting the year at slightly above US$47,700 ($67,632), Bitcoin has slid 57.41% year-to-date, hovering above US$20,300 as of Nov 3. “Even after the correction, it is still one of the world’s largest securities. But that increased market cap, volume and trading don’t mean the volatility falls.”
Crypto assets were once considered a haven that rivals gold. However, they are “highly correlated” with traditional assets, says Metcalfe, especially tech stocks. “It’s performing very similarly to tech stocks, even though it’s a very high-market cap asset.”
In March 2021, a wave of liquidity — riding on Covid-19 recovery hopes — forced retail money into equities and bonds. Says Metcalfe: “It also forced money into crypto. Unfortunately, when the liquidity wave crashed, you lost out. When the tide retreated, it [fell] further.”
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Still, he believes Bitcoin is in “much safer hands today” than it was at the start of the year. Citing data from blockchain analytics firm Glassnode, he says that entities currently hold 80% of outstanding Bitcoin with similar characteristics of institutional investors who are “typically long-term accumulators” — “entities and wallets that typically don’t sell”.
Compared to the IMF’s forecast of a one in four chance that global growth will slow below 2%, Metcalfe thinks there is a one in five chance of a recession in the US. “If a slowdown does occur, it’s going to be cushioned by the fact that consumer or accumulated savings in the US are still very high thanks to the pandemic.”
Corporates are also cash-rich.
Balance sheets were the thing that caused the deep recession after the global financial crisis. Today, balance sheets are going to help limit the slowdown.
While Metcalfe believes headline inflation has “probably peaked”, healthcare and housing “look to be sources of quite sticky inflation”.
He adds that supply-side issues have proven to be temporary, pointing to moderating freight rates. However, core inflation is driven primarily by excess demand. “[Inflation among] US housing should begin to correct, but healthcare is inflecting higher, which is a bit of a problem.”
Stagflation and recession Inflation among agricultural commodities is cause for concern, says Metcalfe. “Food shows no inflexion point at all. So, food and food price inflation in developed markets is still problematic and rising.”
Outside of the US, stagflation and recession are “almost guaranteed” for Europe next year. Relative to Europe, US equities “still have high-quality earnings”, while treasury bonds are “still the place to go for haven reasons”.
But the strength of the US dollar may soon become a problem, warns Metcalfe. “I think the Fed (US Federal Reserve System) might get to peak rates before other central banks. You can see a lot of capital still going into the US; it’s getting expensive to hedge the dollar — that means the dollar will continue to overshoot.”
The dollar is already significantly overvalued, but he thinks the greenback — dubbed “King Dollar” by pundits for its gains — will “get even crazier”. “I think we’re going to discuss the need for coordinated intervention to stop the dollar in three to six months.”
The firm’s recommended asset allocation is neutral between equities and bonds. “Of the two, I can see being able to make a case for bonds. For equities, that will require greater confidence that the peak in US [interest] rates [will be] 4% to 4.5%, with inflation starting to come down.”
Metcalfe sees “value opportunities” in the next three to six months, which may appear first in bonds. “If you’re somewhat defensive, you would still want to stay in treasuries. However, I think there will be plenty of opportunities in emerging market bonds relatively soon.”
