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Over the summer, a familiar fairy tale kept popping up in financial markets: Goldilocks.
The release of key economic data is neither too hot nor too cold, like porridge for the story’s brave young hero of the same name. The employment and inflation data were bright enough to suggest the U.S. economy had weathered the Fed’s aggressive rate hikes particularly successfully, but also dim enough to suggest the Fed may not need to do much before inflation picks up. its box.
Now that summer is over and tans are fading, investors remember the end of “Goldilocks,” when a toddler is chased out of his wits by hostile animals into the forest. Sure, the kid steals a bit of porridge, breaks a chair, and briefly exercises her rights as a squatter at the woodland cabin, but in the end, the winner of this story is the bear.
The same goes for the market. The benchmark S&P 500 index posted its first monthly loss since February in August, while September opened on a weak note on both sides of the Atlantic. UBS strategist Bhanu Baweja and his colleagues have written that we have reached “Peak Goldilocks”.
Oil prices are fueling nervousness. Brent crude topped $90 a barrel this week for the first time since November after Saudi Arabia and Russia said they would extend output cuts. The benchmark has now climbed by a quarter since June, reigniting fears that the inflation genie has fallen but not gone away.
Suddenly, the story investors tell themselves to help make sense of a volatile market has changed. Should this matter? Arguably not. But as everyone tries to discover how and when economic growth and inflation will give way to the elusive U.S. recession, it does. “It’s a narrative-driven market,” said Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.
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Over the past few months, the dominant narrative has focused on a soft landing, where the central bank manages to curb inflation without job losses or a severe economic correction.
Of course, the pessimists were wrong this year. The U.S. comfortably avoided a recession, and stocks also rose sharply, breaking the consensus forecast for a downtrend. Ahmed, who readily admits he made the same mistake, dropped his call for a 2023 recession in June. But he remains convinced that the damage from the Fed’s series of aggressive rate hikes will come.
So far, riskier parts of the growth-focused equity and corporate bond markets — still buoyed by excess liquidity in the financial system and enthusiasm for artificial intelligence — have been behaving as if the rate hikes we’ve seen so far don’t matter . It’s hard to imagine this going on forever, especially when all those teetering companies that enjoyed cheap money in the wake of the pandemic refinance their debt at higher rates over the next year or two.
Ominously, the pain has been evident in Europe, where stock markets have stagnated and the euro has been trading lower against the dollar for weeks. “Europe is at an interesting moment and a complicated situation,” said Gustavo Madros, head of research at Ashmore. It’s short-term bank loans.” Poland’s sharp rate cut this week could end up being a warning sign for the future in more developed markets.
Suddenly, market participants found it easier to articulate a case for caution. Oil prices are one of them. This week’s surge in European gas prices also brought a sense of déjà vu. The Chinese economy is clearly under pressure and puts additional pressure on Germany’s key industrial sectors. Even Apple, considered a safe-haven stock in recent years, fell 7% this week after Chinese authorities pressured government employees to stop using iPhones. That’s a cool $200 billion hit and a big challenge for a U.S. market heavily reliant on a handful of tech stocks.
Now even good news is bad news. Data on Wednesday showing the unexpectedly poor health of the U.S. services sector hit stocks as investors worried the Federal Reserve had not done enough to keep inflation low on a sustained basis. Instead, it may have to maintain pressure for a longer period of time.
It all sounds reminiscent of 2022 — a dire year for investors who have to deal with falling stock markets and falling bond prices. This time is different, as a 13% rise in global stock markets so far this year provides a cushion, as does fat yields on even the safest government debt.
If you’re willing to hold these bonds to maturity, you have nothing to worry about. But Bank of America noted this week that the U.S. 10-year Treasury note is on track to fall for a third year in a row — a streak unprecedented in U.S. 250-year history.
Unless the stock market can end the fairy tale this year, 2023 could be bleak again.
katie.martin@ft.com
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