• Covid and fears about the global economy pushes central banks to lower rates and pump cash into the system, sometimes with outright cash in consumers’ bank accounts.
  • The purchasing power momentarily increases and pushes people to spend.
  • In parallel, global supply-chain and production issues push prices higher.
  • Demand isn’t stopped as people have cash and prices rise further.
  • Central banks pick-up on inflation and start to raise rates to push demand down and thus lower the rapid price increase. But the supply side of the equation isn’t resolved.
  • With rising rates, valuations of all businesses need to be re-evaluated, because of what it means for business, demand, debt but also just the risk-free rate of holding bonds (whose real-rate is still not positive but less negative).
  • But here’s the kicker: When we reach a point where a recession is looming, it impacts both consumer sentiment and central banks decisions to support the economy.
  • This is made easier because with prospects of a recession, commodity prices drop and so the cost of production does too, to a certain extent… so now prices are going down by themselves, regardless of central bank yields (which should be resolving consumer purchasing style as well). Like, if there’s a recession, you could expect gas prices to go down, or lumber to be cheaper, etc. and so inflation gets resolved by the negative economic expectations.
  • …and that might lead to less rate hikes, a pause or even a reversal and so the valuations of stocks that were pushed down to extremes (relatively speaking) can now go back up… so that recession and the potential reaction from the Fed could actually be good for valuation and therefore price action in the stock market, in the real estate market, etc. The below chart shows the extreme risk-off sentiment or the fact that it’s now become a crowded trade that can endure for a while but has also a certain likelihood of reversing

--

--

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Justin d’Anethan

Justin d’Anethan

Passionate about financial markets, long-term investments, the occasional short-term trade and disruptive technologies.