BLOG

While many market participants are expecting a “soft” landing for the economy after more than a five per cent rise in interest rates, the evidence for a hard landing is mounting.

• Unemployment just rose from 3.4% to 3.8%


• The personal savings rate just rose by 3% with consumers anticipating harder times ahead.


• High yield bond defaults are up 1.6% to 3.2%


• Credit card delinquencies are up from 0.8% to 1.2%


• Auto delinquencies are up 5% to 7.3%


• Business confidence has been falling since late 2020.


• The bond yield curve is now steepening quickly; having been very inverted at -1.1%, it is now at only -45 bps.

The 10-year Treasury bond yield is now at a sixteen year high.

When bond yields go up because of higher interest rates, bond prices go down. When longer term bond yields go up by more than shorter term bond yields, it is known as “bear steepening.” This condition is dangerous to markets, because of the effects on mortgages and corporate loans, which become much more expensive. Long bond prices are much more sensitive to changes in yields than short dated bonds. For example, a ten-basis point move up in 30-year yields is as much as ten times more powerful on prices as the same increase in a two- or five-year bond yield. This means that entities that invest in long dated bonds like pension funds, insurance companies, or fragile banks can be vulnerable to much lower bond prices. Bear steepening can be dangerous when the economy is weakening; in Sept-Nov. 2000, May-June 2007, and Sept.-Nov. 2018 we saw, in all three cases, bear steepening marking the end of a bull market for stocks. However, in all three of those cases, inflation was much lower, which permitted the Federal Reserve to cut rates and stimulate the economy. The Fed is now telling us that higher rates today will not lead to more interest rate cuts tomorrow. In their September meeting, “higher rates for longer” was the theme as expectations over any near-term interest rate cuts were pushed out largely to 2025, due to the intractability of inflation.

Higher debt defaults seem inevitable as the lagged impact of higher interest rates flows through to consumers and businesses. While the market is currently expecting the Fed to stop raising rates when it gets to 5.45%, it is now entirely possible that we see more unanticipated rate hikes. Keep in mind that some $4 trillion of investment grade and high yield debt is being refinanced at much higher rates this and next year, while at the same time banks are tightening their lending standards.



As a result, commercial loan growth is now poised to go negative year-on-year.

Mortgage rates are still climbing, now at 7.41% These high rates, combined with banks’ increasing reluctance to lend, is leading to a drop in new home sales to a five-month low. New housing construction was down 11.3% in August, 1.7% below the previous year. But high rates are making their biggest impact in the commercial real estate market. There is a “wall of debt”- some $1.4 trillion of commercial real estate debt, which will be maturing through 2025. These loans will need to be refinanced at much higher interest rates, and are provided mostly by small regional or community banks. In all but the biggest 25 US banks, 67% of all loans are for commercial real estate. The impending credit crunch is likely to negatively impact access to credit by small and medium sized businesses, which leads to less hiring and less spending.

Oil prices have soared in the third quarter to new cycle highs, as markets consider the effects. The US strategic petroleum reserve is at lows, and overall total oil storage levels are very low. Crude oil prices may be heading even higher on supply concerns, and JP Morgan analysts are predicting $150 per barrel by next year. While our major inflation index, the “core” CPI, strips out food an energy from inflation, it should be noted that energy prices also have important indirect effects on inflation. High oil prices come at a time when consumers are already stretched. Student loan repayments of, on average, $400 per month per student must be repaid starting October first (after a Covid moratorium) and maxed-out credit cards are now subjected to an average 28% interest on a record $1.03 trillion total. These factors combined are leading to a drop in consumer expectations, as well as confidence in the present situation:



The much feared government shutdown has been reprieved for 45 days. Although Wall Street would not welcome the chaos that would ensue with a shutdown, what is truly feared is a downgrade of the US credit rating by either S&P or Moody’s. Last week, Moody’s signaled that a government shutdown would harm the country’s credit, while the former chairman of S&P’s sovereign rating committee said that the U.S. is in a weaker position now than when S&P downgraded its sovereign credit rating in 2011.

On a positive note, productivity among the US workforce is improving, and onshoring and infrastructure investment is robust. American and foreign manufacturers are onshoring to the US to avoid geopolitical risks and supply chain risks.

The federal government’s spending on public infrastructure is boosting demand for new construction equipment, up some 8.4% over the past year.

Federal deficits have become a preoccupation to the bond markets, in addition to inflation worries. The US funding deficit is a result of inflation, as the government must spend more on interest payments to service its debt. Record amounts of Treasury bond issuance is also exacerbating the bond selloff. The bond market is sending a clear message to Washington to cut the deficits. If the government does not act, bond yields will rise further and cause a recession and a credit crunch.

GLOBAL DISCLAIMER: THIS REPORT HAS BEEN PREPARED BY METIS CAPITAL MANAGEMENT LLC. THIS REPORT IS FOR DISTRIBUTION ONLY UNDER SUCH CIRCUMSTANCES AS MAY BE PERMITTED BY APPLICABLE LAW. IT HAS NO REGARD TO THE SPECIFIC INVESTMENT OBJECTIVES, FINANCIAL SITUATION OR PARTICULAR NEEDS OF ANY SPECIFIC RECIPIENT. IT IS PUBLISHED SOLELY FOR INFORMATIONAL PURPOSES AND IS NOT TO BE CONSTRUED AS A SOLICITATION OR AN OFFER TO BUY OR SELL ANY SECURITIES OR RELATED FINANCIAL INSTRUMENTS. NO REPRESENTATION OR WARRANTY, EITHER EXPRESS OR IMPLIED, IS PROVIDED IN RELATION TO THE ACCURACY, COMPLETENESS OR RELIABILITY OF THE INFORMATION CONTAINED HEREIN, NOR IS IT INTENDED TO BE A COMPLETE STATEMENT OR SUMMARY OF THE SECURITIES, MARKETS OR DEVELOPMENTS REFERRED TO IN THE REPORT. THE REPORT SHOULD NOT BE REGARDED BY RECIPIENTS AS A SUBSTITUTE FOR THE EXERCISE OF THEIR OWN JUDGMENT. ANY OPINIONS EXPRESSED IN THIS REPORT ARE SUBJECT TO CHANGE WITHOUT NOTICE. THE ANALYSIS CONTAINED HEREIN IS BASED ON NUMEROUS ASSUMPTIONS. DIFFERENT ASSUMPTIONS COULD RESULT IN MATERIALLY DIFFERENT RESULTS. THE ANALYST RESPONSIBLE FOR THE PREPARATION OF THIS REPORT MAY INTERACT WITH TRADING DESK PERSONNEL, SALES PERSONNEL, OTHER ANALYSTS, JOURNALISTS, AND OTHER CONSTITUENCIES FOR THE PURPOSE OF GATHERING, SYNTHESIZING AND INTERPRETING MARKET INFORMATION. METIS CAPITAL MANAGEMENT LLC IS UNDER NO OBLIGATION TO UPDATE OR KEEP CURRENT THE INFORMATION CONTAINED HEREIN. THE SECURITIES DESCRIBED HEREIN MAY NOT BE ELIGIBLE FOR SALE IN ALL JURISDICTIONS OR TO CERTAIN CATEGORIES OF INVESTORS. OPTIONS, DERIVATIVE PRODUCTS AND FUTURES ARE NOT SUITABLE FOR ALL INVESTORS, AND TRADING IN THESE INSTRUMENTS IS CONSIDERED RISKY. MORTGAGE AND ASSET-BACKED SECURITIES MAY INVOLVE A HIGH DEGREE OF RISK AND MAY BE HIGHLY VOLATILE IN RESPONSE TO FLUCTUATIONS IN INTEREST RATES AND OTHER MARKET CONDITIONS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. FOREIGN CURRENCY RATES OF EXCHANGE MAY ADVERSELY AFFECT THE VALUE, PRICE OR INCOME OF ANY SECURITY OR RELATED INSTRUMENT MENTIONED IN THIS REPORT. METIS CAPITAL MANAGEMENT LLC ACCEPTS NO LIABILITY FOR ANY LOSS OR DAMAGE ARISING OUT OF THE USE OF ALL OR ANY PART OF THIS REPORT. CERTAIN OF THE INFORMATION CONTAINED IN THIS PRESENTATION IS BASED UPON FORWARD-LOOKING STATEMENTS, INFORMATION AND OPINIONS, INCLUDING DESCRIPTIONS OF ANTICIPATED MARKET CHANGES AND EXPECTATIONS OF FUTURE ACTIVITY. METIS BELIEVES THAT SUCH STATEMENTS, INFORMATION, AND OPINIONS ARE BASED UPON REASONABLE ESTIMATES AND ASSUMPTIONS. HOWEVER, FORWARD-LOOKING STATEMENTS, INFORMATION AND OPINIONS ARE INHERENTLY UNCERTAIN AND ACTUAL EVENTS OR RESULTS MAY DIFFER MATERIALLY FROM THOSE REFLECTED IN THE FORWARD-LOOKING STATEMENTS. THEREFORE, UNDUE RELIANCE SHOULD NOT BE PLACED ON SUCH FORWARD-LOOKING STATEMENTS, INFORMATION AND OPINIONS.