What would it take to put the global economy into a tailspin?
asserted
it → take → tailspin
The Bank of America, which is worth roughly $395 billion ($US275 billion), and dependent to a degree on functioning financial markets, is asking itself that question.
asserted
which → function → question
The answer lies in the cost of debt.
asserted
answer → lie → debt
Low productivity, excess demand, the boom in artificial intelligence and the Iran war are all pushing up the cost of borrowing.
asserted
productivity → push → borrowing
Despite this, interest rate increases have not yet done too much damage to share markets, property prices, or indeed many advanced economies.
asserted
increases → do → markets
But Bank of America's head of interest rates strategy, Mark Cabana, has estimated the cost of borrowing, or level of interest rates, that would cause financial damage.
asserted
that → estimate → damage
He says we're not far from that point.
asserted
we → say → point
It recently raised America's benchmark interest rate by a quarter of a percentage point, to a range between 3.75 per cent and 4 per cent.
asserted
It → raise → cent
The trillion-dollar question many central banks are asking themselves is what interest rate level will work to lower overall demand in the economy?
asserted
level → ask → economy
And crucially, when does the cost of borrowing become financially dangerous?
asserted
cost → become → borrowing
Mr Cabana, who was previously an analyst at the New York Federal Reserve, said the recent US bond market sell-off has led to yields rising to multi-decade highs.
He also said the sell-off was not severe enough to cause steep falls in asset prices.
asserted
off → say → prices
Basically, yields rise when bond prices fall.
asserted
prices → rise → ?
Yields also rise ahead of increases to central bank interest rates.
asserted
Yields → rise → rates
"We expect that rates will continue to rise and that the curve will continue to flatten in the US, but also likely globally, simply because the level of interest rates today is not restrictive," Mr Cabana said.
asserted
Cabana → expect → rates
Put simply, Mark Cabana does not believe US interest rates are currently high enough to significantly slow economic growth
"
asserted
rates → Put → growth
And what that means is that interest rates have not risen high enough to actually see any type of slowing in macroeconomic data.
"
asserted
rates → mean → data
So it seems like the market is generally comfortable with the extent of the rate move thus far."
asserted
market → seem → move
US interest rates heading higher
Goldman Sachs has pushed its forecast for the next US interest rate hike to December.
asserted
Sachs → head → December
It did this after a softer-than-anticipated inflation reading last week cooled expectations the Federal Reserve would hike rates again in October.
asserted
Reserve → do → October
A December rate hike would push the fed funds target to 4 per cent to 4.25 per cent.
asserted
hike → push → cent
This interest rate level, Mark Cabana believes, is approaching the economic and financial danger zone, with greater concerns if expectations push into the high 4s and mid 5 per cents.
asserted
expectations → believe → cents
"That might be more consistent with some signs that we start to see a tightening of financial conditions and slowing in macroeconomic growth," he said.
uncertain
he → start → growth
Australia is already seeing a cooling of the housing market, and the share market is also well off its August highs.
asserted
market → see → highs
The Australian government's 10-year bond yield — or the interest rate it needs to pay to borrow money for a decade — has risen to its highest level since 2011.
asserted
it → need → 2011
All working Australians would be mindful of this because it has direct implications for their superannuation balances.
asserted
it → work → balances
Mr Cabana recently visited Sydney to, among other things, address the nation's superannuation heavyweights.
asserted
Cabana → visit → heavyweights
"I know that they are extremely focused on this question as well [of when interest rates will be restrictive to growth]," he told The Business
Australian superannuation funds have tens of billions of dollars' worth of Australian workers' cash tied up on Wall Street, including the big tech companies.
"Our guidance to them would be that they should become much more concerned if you do see that macro data continues to be strong and that financial conditions are not showing signs of caring."
asserted
conditions → know → caring
Put simply, Cabana is saying that if the US economy continues to grow, and inflation pressures persist, US interest rates will need to push higher.
"
asserted
rates → put → ?
That will mean that [US interest] rates may need to rise further and rates that have a 5 per cent or 5.5 per cent level.
uncertain
that → mean → level
"
Inflation worry is front and centre
Others see more leg room for asset prices to stretch out.
asserted
prices → see → room
VanEck's investment strategist Anna Wu believes the investment boom underway, particularly in relation to artificial intelligence (AI), will overwhelm any short-term financial market gyrations.
asserted
boom → believe → gyrations
"Past rate hiking cycles have taught investors tough lessons, especially 2022, when the Fed lifted rates from near zero to above 4 per cent in nine months, and to above 5 per cent by mid-2023," she said.
asserted
she → teach → mid-2023
"Equities fell because rising rates hit valuations before company profits could catch up.
uncertain
profits → fall → valuations
Ms Wu believes this time is different.
asserted
time → believe → ?
"We are in a slightly different regime now," she said.
asserted
she → say → regime
"Bond markets expect inflation to stay around its five-year average.
asserted
inflation → expect → average
"That means US yields are rising largely because investors expect stronger growth, not runaway prices."
asserted
investors → mean → growth
Anna Wu draws the distinction between inflation worries and interest rates responding in a healthy way to the growing US economy.
asserted
Wu → draw → economy
"Investors should be risk aware,"she said.
asserted
Investors → say → ?
But as Reserve Bank governor Michele Bullock put it last week, when asked if the RBA would need to push the economy into recession to achieve its inflation target, " I guess possibly."
uncertain
I → put → target
…and 3 more, not listed.
The Aporia
