The Global Housing Market Crisis of 2023

Sadly, for many people throughout the world, higher interest rates besetting global property markets are diminishing the prospects of home ownership. In 2022 central banks started employing quantitative tightening monetary policy and raising interest rates in their fight against inflation, the resultant shock that rippled through global housing markets gave way to the reality that the real estate boom was at an end, marking a finish to the millions made by people across the globe.

It would appear that higher interest rates are here to stay for a while longer, keeping borrowing costs high, this together with a shortage of homes are keeping prices elevated. This has resulted in those homeowners who have had to reset their loans facing increased financial hardship, whilst in many areas housing is now less affordable. For instance, in the United States the home market is dominated by the 30-year mortgage and today it is effectively frozen, as buyers are being squeezed because those with lower interest rate mortgages are reluctant to sell. 

In each country across there are differing scenarios, but in the end they are all dragging down global economies, as whether they rent or buy, people are using more of their net income for housing. Take for example Canada and New Zealand, where those who bought at the top are now struggling with higher repayments on their loans. Across the world landlords are suffering from distress and in many areas higher interest rates have negatively impacted on the building of homes. 

Experts suggest that the “Golden Age” of single family homes is ancient history with the cost of home loans doubling in some parts of the world. If potential home buyers bought just after the global financial crisis then in most parts of the world owners would now have built up a substantial amount of equity. They predict that the next ten years will be an uphill battle for many new home buyers or even for those looking to trade up. For example, in the United States the current 30-year mortgage is circa 7.4% and over the next decade is expected to be around the 5.5% mark, whereas in the comparable low early part of 2021 it was 2.65%. In 2011 the average 30-year mortgage was circa 3.9% and slowly reduced over the next decade, making it the optimal time to buy.

Interestingly, back in the 1980’s, John Quigley, an economist at the University of California, Berkeley, identified what was to be known as the lock-in effect. Between 1978 and 1981 mortgage rates had doubled from 9% to a staggering 18%, which left millions of households paying well below the market rate for mortgages . Therefore, to purchase a new home meant adding possibly unsustainable costs to the monthly household bills, which was a powerful reason to not to move, hence the lock-in effect.

Economic incentives quite often make people forget lessons learnt in the past, as Quigley’s “lock-in effect” was quietly forgotten as interest rates fell back. However, this all changed when the Covid-19 Pandemic hit. In 2020 the US housing market briefly shut down, then a housing boom exploded (not seen in decades) due to a combination of plummeting borrowing costs and stimulus payments. For the first time in fourteen years existing home sales hit six million annually. The market was seeing house hunters purchasing homes far from the coast (the most popular areas before the pandemic), mainly due to the new remote working policies. Today, the quantitative tightening policies of the Federal Reserve has reduced demand and reduced supply even more due to Quigley’s “Lock-in Effect”

Unfortunately for home buyers, even as inflation begins to recede and central banks reverse their strict monetary policy of interest rate hikes, they have to face the reality that borrowing costs on their mortgages may never return to the lows during the fifteen years seen since the global financial crisis. In the past, if interest rates shot up, consumers were confident that rates would return to what was perceived as normal. They would be able to struggle through the higher rate or take on mortgages with a view to refinancing at a later date when interest rates once again fell. Today, these options will not be available because as previously stated, higher interest rates and costs look like dragging on for quite a number of years. 

Experts in the United States are referring to the housing market as the start of the glacial period due to the collision of the highest mortgage rates in a generation (timeline 20 – 30 years ), a low inventory and rising prices. As a result, recently released data shows sales of previously owned homes having dropped to their lowest level since 2010, with contract closings in October falling by the most in the last twelve months and dropping by 4.1% from September of this year. Further data released from ICE (Intercontinental Exchange Inc) show that the housing market in the United states is the least affordable in forty years. The data further confirmed that circa 40% of average household income is now required to purchase your average home. 

Expert analysts predict that in 2024 the housing market will feel the most severe effects of higher interest rates and sustained higher mortgage rates as they estimate transactions in this market will fall to their lowest levels since the 1990’s. The glacial period that is being deferred on the United States housing market will have many knock-on effects. For instance, families may be forced to live together, and as the elderly age without moving, homes will be kept off the market which could have been made available for purchase by younger buyers. Furthermore, there are a vast number of homeowners who are unaffected by the increase in interest rates (as 30-year mortgages were negotiated when interest rates were low), and they are also sitting on a near-record amount of equity. In other circumstances, there may have been forced sales or foreclosures which would have opened up purchasing opportunities for potential buyers. 

Away from the United States things are just as bad in many housing markets with New Zealand being an extreme case. New Zealand enjoyed possibly one of the largest pandemic booms as in 2021 property prices rose by an incredible 30%, and according to data released by the Reserve Bank, circa 25% of the then current stock of mortgage lending was taken out in 2021 and a fifth were first time buyers. However, mortgages are only fixed for three years or less, and interest rate hikes of 5 ¼% since October 2021 have sent mortgage repayments through the roof. The Reserve Bank has estimated that household disposable income that is used to finance mortgage repayments will be circa 20% by June 2024 up from a low in 2021 of 9%, more than double of what they were paying. However, thanks to strong wage growth many households are just about managing.

In China the property slump is not driven by interest rate hikes, but two years ago a government led clampdown on developers borrowing was the forerunner to a growing crisis. Today, China’s property market, which once accounted for 30% of the economy, is struggling with unresolved debts and slow sales leading to an economic decline. Potential buyers have been reluctant to invest in homes yet to be finished, due to a legal system that is not prepared to restructure debt and spreading defaults by home builders. However, the government has advised that it will target selected developers for financial aid, but insist the funding is to finish housing projects, not to repay debt.

In Canada many citizens profited from the housing boom of the last decade, and by 2020 had come to own more than two homes which, in British Columbia and Ontario, accounted for just under 33% of housing stock. However, data shows the introduction of higher interest rates meant that in a city such as Toronto owning a condo was now yielding only circa 3.5% after mortgage repayments and costs whilst Canadian Government Bonds were paying 5%. The high rates of interest have certainly put a damper on interest in new housing purchases, whilst some with investment properties are facing negative cash flows, forcing owners to sell, if indeed they can find buyers. 

Elsewhere, Europe is facing a housing crisis, as a collapse in home building threatens an increase in shortages over the next five years. Those countries that are hardest hit are among the wealthiest with building permits in France down by over 25% in seven months through to July 2023, and in Germany building permits were down 27% in the first half of 2023. In fact, when Olaf Scholz’s coalition took power in Germany in 2021, the Chancellor’s pledge of adding 400,000 new homes per year was sadly way behind schedule. In fact experts suggest that Germany won’t reach this figure until 2026 at the very earliest.

There is a massive construction crash in Europe with governments reluctant to spend any more funds than are absolutely necessary as they continue the battle against inflation in the post-covid era. Recent data shows that in Sweden in the first ten months of 2023, 1,145 companies within the construction industry filed for bankruptcy, an increase of 32% from 2022. 

Many politicians are advocating more spending on housing, even the Labour party in the United Kingdom (polls suggest a shoo-in at the next general election) are promising to overhaul the planning system and build 1,500,000 over the next term of parliament. However, as in many countries a manifesto promise and reality are often many miles apart. The German government has offered to boost public investment and simplify licensing procedures, but what analysts describe as a tepid response is not expected to make any significant impact. 

Without government investment and private sector investment many citizens across the world  will be unable to buy their own homes destroying the dreams of home ownership. The only winners appear to be those buyers in the United States locked into the 30-year mortgage when interest rates were at their lowest. The rest of the world can only hope that the property market returns to relative normality, but how long that will take is anybody’s guess.

Gold Hits Record High December 2023

This week, gold touched an all-time high of $2,135.39 as the metal continued on a rally which started in early October of this year and has seen the metal gain 16%. Gold last reached a record high back in August 2020, when the Covid-19 pandemic sparked a rush into gold as a safe haven. As the world becomes more volatile, the old adage of gold being a safe haven tends to make it increase in value.

This of course can be seen in the continuing war between Russia and Ukraine, as well as the continued conflict between Israel and Palestine, providing a geopolitical risk as a reason to invest in gold. Furthermore, the dovish stance being taken on interest rates by the Federal Reserve in the United States has given the gold price some staggering momentum.

When the Federal Reserve first started hiking interest rates, assets such as bonds became more lucrative for investors due to the higher yields on offer. Consequently, the demand for gold lessened due to the fact the metal carries no interest rate thus diminishing investor appeal. Conversely, when interest rates come down the appetite for gold increases, and the prospect of easing money supply and reducing interest rates appears to have been confirmed by recent comments coming out of the Federal Reserve.

Analysts are advising that gold’s surge towards a record high was aided by Federal Reserve Governor Christopher Weller, who indicated that interest rates will not have to be increased to get inflation to return to 2%. Further dovish remarks followed from the Chairman himself, Jerome Powell, who said the central bank’s policy rate was now well into restrictive territory, which suggests that rate increases have now concluded.

This potential end to rate hikes will prove beneficial to gold, as the metal tends to struggle under higher rates whilst benefiting from lower rates. Therefore, as mentioned above, gold is not only rising from geopolitical risks, (also 41% of the world’s population will go to the polls next year,) but from traders aggressively pricing in rate cuts from March 2024. Indeed, experts advise that the swaps markets are now predicting a better than even chance of a rate reduction in March 2024, and are pricing in a cut in May of the same year. The recent decline in the value of the dollar has also spurred investor interest in gold as the metal is usually valued against the greenback. 

Experts suggest that gold may well go higher as there are many investors still on the side-lines, which increases the possibilities  of further spikes/rallies in gold. Previous gold bull markets have been driven by investors using exchange-traded funds or ETFs*, but analysts advise that investors in the mechanism have seen sellers for much of 2023 down 20% from the high of 2020. 

*Gold ETFs – This is a very popular way for investors to buy gold as they do not have to go through the process of owning the metal. Gold ETFs enjoy good liquidity and investors can buy and sell shares of the ETF on the stock exchange. When a purchase of shares is made the fund manager must buy the equivalent amount in physical gold. This not only will increase the price of gold but can act as a signal to the broader market that demand is increasing thereby impacting investor sentiment.

Furthermore, experts advise that the current price of gold (down at the time of writing form the high of USD2,135.39 to USD2019.17) may well be underpinned by the continuing support of purchases by governments and central banks. For example, Poland has bought circa 300 tonnes of gold in the past few years falling in line with the Eurozone average of gold to GDP ratio. This is a covert requirement* and as such analysts suggest Poland will buy an additional 130 tonnes of gold. 

*Covert Requirement – is referred to because some central banks within the Eurozone (e.g., Belgium) refuse to be transparent with regard to the gold reserve alignment on the grounds of professional secrecy. 

Market sentiment appears to favour a bull run in 2024 as experts predict that the Federal Reserve will cut US Dollar interest rates four times in 2024. However, if inflation figures do not match market sentiment and rates are put on hold or even hiked once more, traders and investors will not hesitate to cut their positions and gold will fall back to weaker levels.

Is it Time for the USD25 Trillion Global Cargo Trade to go Digital?

Paper documents still rule the world in global cargo trade. Indeed within this USD25 Trillion business, there is, at any one time, four billion paper documents in circulation. Importers, exporters, banks, brokers, financiers et al all rely on paper documents, which finance and move global resources around the world. It is a system that has seen little change since the 19th century and yet paper documents are frequently subject to fraud (i.e., fake or altered), get lost, and can with any particular journey add huge amounts of time.

With regards to time, data released by experts within this area suggest that the time to process a single bill of lading (paper document along with others) required for the transportation of goods, from issuance to customs clearance which for example includes preparation, issuance, shipper to bank, shipper bank to buyer bank, buyer bank to buyer, submission for customs clearance is circa 16.4 hours. Digitisation will dramatically reduce the time spent on processing.

Company lawyers are still today flying many miles to get a bill of exchange signed off at the last minute. This happened in Singapore in the late 2000’s where a lawyer flew to Hong Kong from Singapore and back in one day, (circa 5,000 miles) in order to have a bill of lading signed off by a client. Typically, this process does not happen every day but digitisation would reduce this process to minutes.

Below are examples of the main type of paper documents usually required under a documentary letter of credit that underpin global trade.

· Bill of Exchange or Draft

· Airway Bill (if air freight)

· Road Transportation Document (if road freight)

· Bill of lading

· Pro Forma or Commercial Invoice

· Insurance Policy and Certificate

· Certificate of Origin

· Inspection Certificate

· Packing List

· Warehouse Receipt – when kept in safe custody after goods arrive.

Based in Paris the ICC (International Chamber of Commerce) currently estimates that circa 1% of transactions within the global trade financing market are fraudulent equating to roughly USD50 Billion per annum. The principals involved, such as traders, banks, other financiers and parties, have, according to recently released data, lost USD9 Billion in falsified documentation over the last ten years. Experts are saying that sending duplicate documents to banks involved in a transaction or falsifying documents are the easiest types of fraud to commit.

Examples of fraud can be seen in the metals market which, going back in history and up to today, has been beset by fraudulent scandals. Some of the latest incidents have encompassed some of the world’s leading trading companies and houses including warehouses connected to the London Metal Exchange (the world’s benchmark futures market for base metals) which were proven to have shortcomings. In the world of metals, the commodity or collateral is usually underpinned by the likes of shipping documents (e.g., quantity ownership, location of goods and quality) and warehouse receipts. Such documents are open to fraudulent misrepresentation, such as being fake whereby the material maybe fictitious, or a single cargo may be pledged for multiple loans which is referred to as over-pledging.

In February of this year a well-known company within the metals industry was left facing a loss of circa USD500,000 as the nickel they had purchased did not contain the nickel as specified in documents. Their modus operandi with nickel was to purchase a cargo of nickel aboard ships then on sell that cargo when the ship reached its destination port. However, on one occasion when investigators in Rotterdam checked the contents of a container containing nickel, they found the contents to be of much lower value materials.

In 2020 a well-known energy group purchased copper from a Turkish supplier, but despite documents confirming the cargo was copper, when the containers were opened, they were full of painted rocks. The list of frauds perpetrated within the metals market is very long indeed, and of course fraud is not just found within metals but anywhere that has paper documentation. It would appear therefore that in order to reduce fraud across the industry, digitisation is the only way forward.

Many advocates of digitisation suggest now is the time to go digital, and make use of blockchain technology. In fact, they go on to say that such technology exists today, resulting in a massive decrease in fraudulent transactions. Furthermore, experts advise that that digitisation will be a boost for the sector, as digitised or electronic bills of lading would increase global trade volume by circa USD40 Billion due to a reduction in trade friction (the reduction in time and paperwork) especially in emerging markets. A very important point as muted by experts suggest from an ecological standpoint that by reducing friction in the container trade (e.g., paper documents), 28,000 tress per year could be saved.

An example of less friction has recently been seen between BHP Group in Australia who shipped nickel in containers to Chinese buyer Jinchuan. The transaction was financed by banks domiciled in each country, and using the ICE Digital Trade Platform the full documentation process amazingly took under 48 hours. Interestingly, 65,000 companies (including leading commodity producers) use the ICE Digital Trade Platform, which provides paperless global management solutions, which include digitisation, automation, and accelerates trade and post-trade operations, finance, logistics, compliance and visibility. Whilst 65,000 companies may sound a lot, remember there are still over four billion bits of paper underpinning global trade in circulation at this very moment.

Detractors say that online hacking is an obstacle to digitisation, but the plain fact is that hacking is a lot more difficult than altering a piece of paper. Indeed, expert opinion advises that that circa USD6 Billion could be saved in direct costs by the major shipping lines if they decided on full adoption of digital bills of lading. Furthermore, it is suggested that financiers such as banks would be more willing to finance those counterparts who are considered to be smaller and riskier if the sector went digital.

Currently, the industry is only transacting 2% of global trade via digitisation. However, change is in the air as ten of the world’s top container shipping lines (nine of which are responsible for in excess of 70% of global container freight), have by 2030, committed to digitalising 100% of their bills of lading, (50% by 2028). Happily, some of the worlds largest and most renowned mining companies have given their vocal support to digitisation, these include Anglo America PLC, Vale SA, Rio Tinto Group and BHP Group Ltd, who are all looking to digitise the bulk shipping industry.

So why is that with all the support for digitisation within the industry, only 2% of global trade has been digitised. The answer is a simple one, as the greatest stumbling block to digitisation is Legal. Whilst shipping companies, insurers, traders, banks and other financiers have all got the wherewithal to go digital, at present the only document recognised by English Law that gives the holder title and ownership to a particular cargo is a paper bill of lading. As a result, any deal or transaction which is not legally secured will not receive funding from a bank or cover from an insurance company, and without either of these two participants there will be no transactions.

As a result of this impasse, on the 20th of July 2023 the Electronic Trade Documents Act 2023, having received royal assent, came into effect on the 30th of September 2023*. This act gives the same legal powers to digital documents as paper ones. This represents a massive step forward, as English Law has legally controlled this industry sector for centuries and underpins circa 90% of global commodities and other trade contracts. France is expected to enact similar legislation towards the end of 2023 whilst Singapore (also a centre for maritime law), passed a similar Act or legal framework in 2021 and in 2022 conducted its first electronic bill of lading transaction.

This act is also based on a Model Law** as adopted by the United Nations, as being a transnational body, it is important that they pass statutes that are acceptable to all countries throughout the world. It has been welcomed by many companies throughout the industry and the Trafigura Group has gone on record by saying “We believe this is one of the solutions which would help in reducing documentary fraud”.

*Electronic Trade Documents Act 2023 – The UK Law Commission published their draft bill in March 2022, which this act is largely based on, and it set out the basis of how, under English law trade, documents can 1. Be dealt with and 2. Exist in electronic form, such that an electronic trade document can have the same effect as a paper trade document. The Act goes on to state that a person may possess, indorse and part with possession of an electronic trade document, and anything done in relation to an electronic trade document has the same effect in relation to the document as it would have in relation to an equivalent paper document. This Act amends the Carriage of Goods by Sea Act 1992 and the Bills of Exchange Act 1882.

**Model Law – UNCITRAL (The United Nations Commission on International Trade law) Model Law on Electronic Transferable Records 2017, aims to enable the legal use of electronic transferable records both domestically and across borders. It applies to electronic transferable records that are functionally equivalent to transferrable documents or instruments. Transferable documents or instruments are paper-based documents or instruments that entitle the holder to claim the performance of the obligation indicated therein and allows the transfer of the claim to that performance by transferring possession of the document or instrument. Transferable documents or instruments typically include bills of lading, promissory notes, warehouse receipts and bills of exchange.

The challenge facing the industry is change. People and companies get stuck in their ways and sometimes it is hard to adopt new processes when the current ones have been in existence for hundreds of years. There are many faults with paper, but it is something that everyone across the ecosystem understands, and whilst there is a global approval of digitisation, few are ready or even keen to be the first to dip their toes in the new waters. Experts have rightly expounded on the fact that if digitisation is to work, then everyone across the supply chain must adopt the same data standards, so that communication can move in the most effective way ensuring verification in a truly interoperable manner.

Southport 1 – 1 Farsley Celtic

For the first time since August of this year Farsley Celtic have gone on a three-match unbeaten run, when at the final whistle on Tuesday evening the spoils were even between themselves and Southport. Sadly, the Celts player/manager Clayton Donaldson was forced off near the end of the game which, together with the earlier injury to Darren Stephenson, meant the Celts were forced to play to the final whistle with only ten men. We wish both players a speedy recovery and hope they will be fit for the visit this Saturday to the Citadel of Radcliffe FC in the second round of the FA Trophy. The run of two wins and a draw now see the Celts mid-table and their current form will surely see them rise even higher.

Is the US Government’s Interest on Debt Spiralling out of Control?

In the United States the annual debt interest they pay on Treasury Bills (US Treasuries) has doubled in the last 9 months, and recent figures released shows that debt interest has passed the USD1 Trillion mark as of the end of October 2023. This figure is representative of 15.9% of the entire United States Federal budget for the 2022 fiscal year, which totalled out as USD6.272 Trillion. 

The heavy borrowing coming from Washington DC has driven up bond yields amid worsening metrics, and such borrowing was responsible for the credit agency Fitch to downgrade government debt back in August of this year. The upward shift in interest rates has put the United States government in a position of having to pay more on interest payments in the coming years than was originally calculated.             

Before the Covid-19 Pandemic no one anticipated that interest rates would go so high, and unless interest rates return to their pre-pandemic levels, interest rate debt will spiral out of control. In fact, experts predict that by 2026 the government’s net interest expense may well be 3.3% of Gross Domestic Product (GDP), which will be a new record being the highest ever recorded. 

As an example of how interest rate debt is spiralling out of control, in October 2023, data released showed that circa USD207 Billion in Treasury notes matured, these notes were issued in 2013, 2016, 2018, 2020, and 2021. Calculations carried out by respected analysts show that the weighted average interest rate* was 1.2%. These notes will be replaced by newly issued debt at an average rate of 5%, and the same will happen every month, (though the amounts will differ) for many months to come. 

*Weighted Average Interest Rate – This represents the aggregate rate of interest paid on all debt in a measurement period. The formula for calculating the weighted average interest rate is,

                         Aggregate Interest Payments ÷ Aggregate Debt Outstanding 

                                              = Weighted Average Interest Rate  

However, things may be looking up for the US government as along with the European Central Bank and the Bank of England, the Federal Reserve announced on 2nd November 2003 that it would keep Overnight Federal Funds steady, which is the second consecutive meeting where rates have remained unchanged. Many operators in the financial markets believe that rates will come down in the new year, which will lighten the load on debt interest payments. However, the Chairman of the Federal Reserve warned that if inflation stops declining he reserves the right to increase rates again, thereby increasing the burden on debt interest repayments.

Are Bull Markets Coming To An End and Will This Affect Asset Managers?

Money managers, who across globe control circa USD100 trillion, have seen an unprecedented outflow of investor funds. One global asset manager based in the United States has seen an exodus of funds amounting to USD127 Billion in the last 24 months. Indeed, within this industry money managers have over the past 10 years faced a massive shift in investor sentiment who have moved to more passive and cheaper investment strategies.

Sadly, these money managers are now facing what may be the end of a mammoth bull run, which has not only masked deep vulnerabilities within the industry but have kept their investments afloat. According to data released from a well know consulting company, in the last 17 years circa 90% of additional revenue received by these money managers has not been from their ability to attract new clients but simply from rising markets. Experts suggest that if there is one more bear market, many of these companies will turn from a slow decline to an impending crash.

Industry experts point out that many of these companies have been literally coasting for years. The coasting is now coming to a stop and if they do not change the consequences will be extremely dire. The salient facts are that amount of client cash that has headed out through the doors of companies such as Invesco Ltd, Janus Henderson Plc, Abrdn (formerly Standard Life Aberdeen Plc, the largest active asset manager in the UK), Franklin and T.Rowe has been in excess of USD600 Billion. Taking these companies as a benchmark for the huge middle of the industry and as proof the world is no longer buying what they are selling, just look at the amount of client funds that have haemorrhaged over the past 10 years.

Experts advise the above five firms represent the pick of the bunch for the middle tier of this industry and as of June 30th, 2023, recently released data confirms that between them they oversaw USD 5 Trillion in assets under management (AuM). However, to show which way the wind is blowing within these companies, whilst the S&P 500 has increased in value by 60% since 2018, with the exception of T.Rowe Price, the other companies have lost circa 33% of their value.

Added to these current problems the industry is still reeling from higher interest rates becoming the norm and the geopolitical tensions between the West and Russia and China. Even Blackrock one of the industry’s leaders has not been immune from the exit of funds as in July, August and September of this year clients pulled a net USD13 Billion from their long-term investment funds. Larry Fink, the CEO of Blackrock was quoted as saying, “Structural and secular changes in business models, technology and most of all, monetary and fiscal policy, have made the last two years extremely challenging for traditional asset management”.

Currently the downward trajectory looks like it will not be changing course anytime soon, and regardless of whether markets are going up or down, passive products* seem to be the favoured by many investors, so they are gaining a lot of traction. Interestingly, as of 30th June 2023, passive investments in mutual funds and ETFs in the United States accounted for 50% of all assets, up from 44% in 2021 and 47% in 2022, whilst 10 years ago it accounted for circa 27%. Essentially investors are ditching those mutual funds with active investments and are joining those with passive strategies which are largely managed by the big companies being Vanguard Group Inc, State Street Corp and Blackrock Inc. Furthermore, there is one more problem money managers have to contend with, and that is cash, and with interest rates remaining high many investors wish to keep money in cash deposits and other similar money market products.

*Passive Products – Passive investing basically refers to a buy and hold strategy for long-term investments, coupled with minimum trading in the market. The most common form of passive investing is Index Investing**, whereby investors seek to replicate and hold a broad market index or indices. Passive investment seeks to avoid fees, is less complex, involves limited trading and therefore is cheaper than Active Products***. The underlying assumption of a passive investment strategy is that over a period of time the market will return positive results.

**Index Investing – This can be an index mutual fund or ETF (exchange traded fund), that tracks a specific market benchmark such stocks and shares in the FTSE 100, the S&P 500, Dow Jones Industrial Average, Nasdaq Composite and the Russell 2000. Other indexes outside the stock market that funds follow are commodity benchmarks such as S&P GSCI Index, the Bloomberg Commodity Index, and the DBIQ Optimum Yield Diversified Commodity Index. These are just three examples pf many commodity indexes that are available to investors. These market indexes make it easy to understand whether the market as a whole, be it stocks or commodities, is gaining or losing ground.

FTSE 100

The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index the FTSE 100 or informally known as “the Footsie” is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalisation.

S&P 500

The Standard and Poor’s 500 or known as the S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in America.

Nasdaq Composite

This is a stock market index that includes almost all the stocks listed on the Nasdaq Stock Exchange. Along with the S&P 500 and the Dow Jones Industrial Average it is one of the three most-followed stock market indices in America.

Dow Jones Industrial Average

Simply known as the Dow Jones or the Dow, this is a stock market index of 30 prominent companies listed on stock exchanges in America.

S&P GSCI Index

This index serves as a benchmark for investment in the commodity markets and as a measure of commodity performance over time. It is a tradeable index that is readily available to market participants of the Chicago Mercantile Exchange

The Bloomberg Commodity Index

This index is a broadly diversified commodity price index and distributed by Bloomberg Index Services Ltd.

DBIQ Optimum Yield Diversified Commodity Index

DBIQ stands for the Deutsche Bank Index Quant and this index is the Excess Return Index which is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world.

***Active Products – Active investing is an investment strategy where traders, money managers and their ilk trade on a frequent basis which requires a constant hands-on approach. Active investing requires the knowledge and expertise to buy into or sell out of a particular asset, bond or share. There are usually a team of analysts who look at quantitative and qualitative factors who use established criteria and metrics to help decide whether to buy or sell. All of these factors add up to active investment being more costly than passive investment. Active investing is particularly attractive during times of market upheaval, and unlike passive investing where the goals are to match the market, active investment’s aim is to outperform the market.

Looking back to the beginning of 2023 data released shows that the active funds did not perform as usual during an upheaval in the market. Indeed, in Q1 the extreme volatility that occurred due to a banking crisis, enhanced geopolitical problems and rate hikes should have produced rich pickings for the active side of asset management. However, according to data released by a US Bank, two thirds of actively managed US large cap funds underperformed their benchmark, the worst quarterly figures since Q4 of 2020.

Experts are even suggesting that many asset managers in representing the middle of the industry may not survive a bear market. A well-known internationally recognised accounting company recently suggested 16% of existing asset and wealth management (AWM) companies and organisations will have been swallowed up or disappeared by 2027, which is twice the historical turnover. In 2022 asset managers had a very tough year with funds or assets under management (AuM) falling by just under 10% from a high in 2021 of USD 127.5 Trillion to USD115.1 Trillion which represented the greatest decline for 10 years. Experts suggest that the during the next two years two of the biggest problems for asset managers and investors will be market volatility and inflation. However, it is estimated that a rebound may well occur in 2027 with assets under management reaching a base case of USD147.3 Trillion being an Annual Compound Growth Rate (CAGR) of 5%.

It has been 14 years since the Global Financial Crisis of 2007 – 2009 and since 2011 the world has enjoyed over a decade of low interest rates and financial stability. Today the world is a different place with high interest rates* and an uncertain economic environment, such trends are somewhat alien to many working in the asset management industry and who are therefore light on experience. Furthermore, as mentioned above, this environment may well be prolonged by the current geopolitical instability plus labour shortages. The problem is that money mangers whilst coping with these problems will have to focus on new investment decisions needed to bring growth and long-term viability which currently, they are failing to do.

*High Interest Rates – Athens Thursday October 26th, 2003, the European Central Bank (ECB) governing council in a unanimous decision held the benchmark rate unchanged at 4%, bringing to an end its unprecedented streak of 10 consecutive rate increases that started in July 2022. However, this rate is still 4.5% higher than the all-time low of minus 0.5% and the decision comes a week ahead of Bank of England and the US Federal Reserve decisions where interest rates are expected to remain steady.

With regards to the markets, the bulls are confident of another run, however despite some bullish signs many investors are saying that the math is not adding up to an on-going rally, especially as there are prospects of a recession on the horizon. Furthermore the 2-year and 10-year Treasury yields remain inverted. An inverted Treasury yield occurs when short-term interest rates exceed long-term interest rates. Under normal circumstances, the yield curve is not inverted since debt with longer maturities typically carry interest rates that are higher than shorter term maturities.

But why are inverted yield curves considered prescient, it is because historically they have been a precursor (not always) to a recession. If indeed there is a recession, (Germany for example is already experiencing a recession), then some of the middle tier money managers had better watch out, as a recession inevitably means a bear market and as explained above a number of middle tier companies could disappear completely.

USD 400 Billion Debt Due in 2024 Putting Emerging Market Companies at Risk

Many emerging market companies are showing signs of vulnerability as circa USD400 Million in debt maturities come due in 2024. The big problem for these companies is the increase in the cost of borrowing as interest rates have hit heights not seen since the global financial crisis of 2007 – 2009. Companies whose jurisdiction reside in developing countries have so far only managed to rollover 10% of what they need, as they see yields on US Treasuries hit a fifteen-year high and borrowing costs going through the roof. 2024 may only be the beginning for these emerging market companies as 2025 will herald USD300 Million worth of bonds maturing.

Experts from the world of emerging market finance suggest that the situation regarding refinancing of these bonds will only get harder and harder the longer the current interest rates remain at their peak. For some companies who are regarded as being of higher quality they will probably get away with paying higher interest rates for refinancing, but for those considered to be of a lower quality their problems may be manifold. These lower quality companies may not be able to find refinancing deals which could lead to defaults and in the more extreme cases bankruptcies. This has been reflected in emerging market junk bonds (EM bonds), which has seen the average yield jump to circa 12% over the last 24 months.

Analysts in this sector of EM junk bonds suggest that the market remains extremely vulnerable especially where companies are domiciled in Ukraine, China, Brazil, Argentina, Colombia and even Dubai. For example, in September of this year in Dubai, Shelf Drilling Holdings Ltd, put a refinancing package together whereby they sold USD1.1 Billion of corporate bonds at the highest yield ever offered of 10.15%. Meanwhile back in June of this year in Colombia, Ecopetrol SA’s refinancing package of USD1.5 Billion had to pay an increase of 4% to 8.65% and 9% compared to 4.65% and 5% two years ago.

In 2023, corporates in emerging markets have so far this year managed to default on USD26 Billion of outstanding debt, and according to recently released data, this takes the total amount of missed repayments during the current rate hikes by the Federal Reserve to circa USD80 Billion. This is a massive increase over the last three years where defaults in the sector of the market in 2020 were USD9.5 Billion and USD9.3 Billion in in 2021. Experts suggest that the market has reached a point where funding allocations to those companies with a B rating or less should be reduced.

In the distressed world investors can usually pick up bargains but such is the nature of this market even they are becoming more wary. Some traders considered to be experts in this arena have been disappointed this year as they have placed bets on emerging market debt distress to ease this year, which would have led to bond gains. Indeed, investors are being pushed to borrow less in the primary market for hard currency, because the Bloomberg EM USD Aggregate Corporate Index* gave a total loss to money managers of 0.6% this year, compared to a similar gauge of US high-yield company debt which showed a gain of 4.3%.

*Bloomberg EM USD Aggregate Corporate Index – The MENA(middle east and north Africa) Bond Index follows the flagship Emerging Markets USD Aggregate index rules and applies additional country constraints. The index includes fixed and floating-rate US Dollar denominated debt issued by sovereign, quasi-sovereign and corporate issuers.

Over the next two years only USD110 Billion of junk rated emerging market bonds are coming due as the remaining outstanding bond issues are considered to be of investment grade calibre. This is the area where most experts feel that problems with refinancing, defaults and perhaps bankruptcies will occur. Such high-yield companies in 2023 have found refinancing particularly difficult with only a combined amount reaching the USD11 Billion mark compared with 2021 where a total of USD 75 Billion was reached in the refinancing arena. Portfolio managers are becoming increasingly selective, and as those weaker companies drop out, those companies with strong management will tend to be picked, especially those that can mange eventual slippage in fundamentals*.

*Slippage in fundamentals – essentially slippage is the difference between the expected price of a trade and the price at which the trade is executed. Fundamentals refer to the primary characteristics and financial data necessary to determine the stability and health of an asset. The data can include large scale or macroeconomic factors and small-scale or microeconomic factors to set a value on business or securities.

The heightened tension in the middle east is not helping matters, and as 2023 approaches its end companies considered riskier than others will not only find their window for debt sales dwindling but competition between the issuing parties becoming fiercer and fiercer. However, as access to dollar funding and indeed euro-funding dries up, experts suggest that the lower rated companies can access bank loans to overcome any financial short-comings or even turn to local currency bonds. They may even access their local markets or loan markets for refinancing or in a last-ditch attempt turn to assets sales.

The current future for interest rates remains on hold as the ECB (European Central Bank), the Bank of England and the Federal Reserve have all kept interest rates at their current level. At the MPC (monetary policy committee) meeting at the Bank of England held last Thursday 2nd November 2023, it was announced that a restrictive policy stance would be needed for an extended period of time to curb Britain’s rate of inflation. In Athens on October 26th, 2023, the European Central Bank left interest rates unchanged after an unprecedented streak (10) of interest rate rises. It was also announced that the rising market talk of interest rate cuts was premature. Finally in the United States, again on the 2nd of November 2023 the Federal Reserve announced that it would keep Overnight Federal Funds steady, which is the second consecutive meeting where they have kept the status quo. However, the chairman of the Federal Reserve Jerome Powell made it very clear that if data shows the slow decline of inflation has stalled, they reserve the right to increase rates despite market predictions of a cut or that we have seen the last of the tightening cycle. Emerging market companies whose junk bond issues are coming due late 2024 and 2025 can only hope that interest rates have dropped significantly by the time their debt matures.

Despite the risks prevailing in the emerging markets bond markets, as highlighted above, many experts suggest that emerging market equities, as opposed to the developed markets, are in line from improving economic growth driven primarily information technology companies and emerging Asia. Interestingly for Q1, Q2 and Q3 of 2023 small cap securities

(MSCI EM Small Cap Index*) have outperformed large cap developed market by 13.7% and over Q3 by 2.9% led by industrials, information technology and materials particularly across South Korea, India and Taiwan.

*MSCI EM Small Cap Index – is a leading provider of critical decision support tools and services for the global investment community. This index includes representation across 24 emerging market countries and has 1,978 constituents. The index covers circa 14% of the free float adjusted market capitalisation** in each country. The small cap segment tends to capture more local economic and sector characteristics relative to larger emerging market capitalisation segments.

**Free Float Adjusted Market Capitalisation – The standard calculation for determining market capitalisation is the total number of outstanding shares including those both publicly and privately held. However, in free float market capitalisation the valuation of the company relies on just the outstanding shares held publicly.

Furthermore, in terms of growth, emerging markets have, on a consistent basis, outpaced their developed counterparts, which is mainly due to robust capital investments and youthful demographics. Experts predict that as recession clouds envelope the United States, Great Britain and Europe, growth differential is expected to widen further and be at its highest level since 2013. Analysts are saying that 2024 will see emerging markets becoming the growth engines of the world with economies in Africa, Central Asia and the Middle East showing remarkable resilience. They go on to conclude that emerging market bonds (despite the potential current crisis) continue to hold promise, and therefore could represent an attractive investment, but a rational approach needs to be taken with sensible choices which could reap good rewards for the sensible investor.

Returning to the EM bond arena, again analysts suggest that credit-rating agencies and money managers believe the situation with emerging market junk bonds will become more complex the longer interest rates remain high. In this challenging environment, external debt cash flows from emerging markers become significant especially over the next couple of years as a number of borrowers could well struggle to refinance at rates considered sustainable in the international bond markets in the higher for longer US Treasury yield arena. So, whilst experts are predicting sustainable growth in emerging markets, traders and money managers will be keeping a weathered eye on issuers, where they are domiciled and the markets they represent therefore making diligent company and country selections.

Will Mexico Finally Join the “A” List? 

One winner from the geopolitical war between China and the United States is Mexico. Indeed, such are the tensions that America is rewriting their global trade agreements where they are seeking to lessen their dependence on supply chains between themselves and their geopolitical rivals and look to find a source of imports closer to home.  

The main beneficiary of such agreements is Mexico, as they have now overtaken China as the largest supplier of goods to the United States, and as of July 2023 China’s share of American imports was 14.6% whilst Mexico led the way with 15%. 

Whilst Mexico is enjoying a resurgence in their export trade, it is interesting to note that 2023 data shows not only can the country boast one of the best performing stock markets, it also enjoys being the owner of the strongest currency. Globally, Mexico is attracting a raft of investors, such interest not being seen since 1994 when NAFTA (North American Free Trade Agreement*) was signed. 

*NAFTA – was enacted in 1994 and created a free trade zone between Canada, the United States and Mexico, and on January 1st, 2008, all quotas and tariffs were eliminated on American exports to Canada and Mexico. As of 2018, Mexico represented America’s third largest trading partner (after China and Canada) and the second largest export market. 

However, history dictates that in the past Mexico has not grasped the opportunities when presented, to turn round their economy. Such opportunities as NAFTA, a great trade deal with the United States, still could not help the Mexican economy. One of the phrases that can be deemed the opposite of a growth miracle is a withering calamity and that could only be said of Mexico’s economy between 1994 and 2017. Trade agreements are supposed to help poor countries grow faster than their richer counterparts, yet by any standards, one can only say the Mexican economy has been sorrowful. 

Even today, Mexico’s growth rate has averaged circa 2% per annum, which is nowhere close enough to reduce poverty, and does not compare favourably with their peers in other developing countries. In fact, in 2000/2001 Poland, Turkey and Malaysia are just three examples of countries who were poorer than Mexico and data confirms that they are now considerably richer. 

So why is it that Mexico cannot use these trade agreements to improve their economy? The answer is that there are many roadblocks both new and old that could be an impediment to the continuation of the current boom. For starters, the current government is seeking to increase its role within the economy and, as a result, has often clashed with business interests across various sectors. 

Therefore, many Mexican companies have been somewhat recalcitrant when it comes to borrowing, which in turn would have increased investments across the board and turned the current boom into a more lasting period of growth. Another impediment to borrowing is the high interest rates, with smaller businesses therefore being unable to utilise credit as a means for expansion. 

Competition is another factor that could derail the potential for Mexican growth, with Japan, Vietnam and other countries, despite not being “near” the United States, are all vying to replace China as an importer to America. Furthermore, Mexican infrastructure is currently under increasing strain from current investments, as there are continuing bottlenecks being created by scarcity of water, limited industrial space and power transmissions that are becoming increasingly more erratic.

Examples of these bottlenecks as voiced by experts can be seen in Monterey, a northern industrial hub in Mexico. In this instance, one expert recounted that in 2021 Tesla was on the edge of opening a factory in Texas and was looking for a supplier of computers that allows autonomous driving for their electric cars. They were currently shipping these computers from China and were looking for a supplier closer to home, otherwise known as friend shoring and nearshoring*. In this instance, Quanta Computer Inc, who had a factory in Monetary, agreed to meet demand by outfitting a building in their complex. Once production started, output was hampered by power blackouts, as the city’s power grid could not keep up with growing industrial demand.

*Friend Shoring – This where companies move their supply chains from geopolitical adversarial countries to those countries considered as geopolitical allies. In the above example, shifting manufacturing from a Chinese supplier to a Taiwanese supplier. The ultimate goal is to stop countries like Russia and China from gaining advantages from leveraging key raw materials e.g., rare minerals, products such as energy, fertilisers and fuel, and computer parts which would disrupt western economies. In other words, it is a barrier to key supply chain blackmail.

*Nearshoring – This where a supply chain or production is shifted from overseas to a neighbouring country or nearby country, usually within the same continent or region. The above scenario, where Tesla moved their supply chain to Monterey to supply computers to their Texas factory, is a prime example.

Monterey is the capital of the district of Nuevo Leon and more than 30 companies have moved to this area after Tesla announced they were to build a factory in Monterey. However, other carmakers have announced EV investments in Mexico such as BMW, Kia Motors and General Motors, and other industries are growing such as plastics and aerospace, found just across the border from California, while home appliance and electronic companies are also expanding.

Data released by the Mexican Association of Private Industrial Parks shows that currently circa 75% of lessees are foreign companies and in 2022 vacancies fell to just 2.1%, whilst in Monterey in order to secure a lease, companies now have to commit to a minimum of 10 years.  Investment in industrial real estate is reaching an all-time high with Corporacion Inmobiliaria Vesta SAB, a real estate developer raising circa USD 450 Million via an IPO in the United States. Furthermore, Prologis, a real estate investment trust based in San Francisco, together with their Mexican arm, are planning a USD 1.2 Billion investment in land and warehouses.

Originally, back in the 1960’s Mexico made its name in the manufacturing sector where factories (maquilas) could be found alongside the US border. These factories employed low wage labour and were quite profitable exporting to the United States. They were also given a boost when NAFTA was signed, which had a knock-on effect to such cities as Monterey. However, small scale farming was a casualty of NAFTA, as Mexico imported American foodstuffs such as corn, thus putting the farmers in jeopardy to the extent that the countryside almost became derelict.

The current President Lopez Obrador, known for his thriftiness when it comes to the public purse, is intent on “levelling up” the north south divide. To this end, projects funded by the public purse include a railway line linking the pacific ocean to the gulf of Mexico. The idea being that the railway will be lined on either side with industrial parks. However, for investors, these proposed industrial parks are so much further from the American border, and this is pointed out by the boss of Nuevo Leon’s largest industrial park who says you can drive to the border crossing in circa 2 ¾ hours, with no red lights.

However, the current President is also known for his anti-business stance, and even sent troops to try and renationalise a private railway, whilst at the same time discouraging foreign companies away from Mexico’s energy markets. However, the president did engage with Tesla as they are seen as job creating initiatives.

Experts suggest that Mexico’s growth rate could increase by 0.7% due to nearshoring, which, whilst not much, would increase growth to almost 3%. In fact, few economies in Latin America have prospered like Mexico’s during Q1 and Q2 of 2023. Despite all positivity on nearshoring, many economists have been downbeat on Mexico’s economy and have been left scratching their heads as they have been proved wrong time after time with Mexico producing strong data and a resilient economy. 

Furthermore, with post-covid supply chain issues still being problematic between China and the United States, (covid related supply chain issues led to a 600% increase in the cost of shipping goods from Shanghai to Los Angeles), Mexico’s economy should continue to benefit form nearshoring, especially given the current strength of existing production and manufacturing with America. 

However, much of the improvement in Mexico’s economy could well depend on whether or not the United States enjoys their much trumpeted “soft landing*”. Such is the lack of agreement on a soft landing, Mexico’s Financial System Stability Committee has expressed caution over the Mexican economy in the coming months. Recently released data in Mexico is mixed, and whilst figures show retail sales and employment growing, exports on the other hand fell reflecting figures showing industrial production as flat. 

*Soft Landing – is a cyclical slowdown in economic growth that avoids recession.  There are mixed thoughts from economists in the United States as to whether or not America will enjoy a soft landing or will indeed go into recession. Some experts believe that a recession is still on the way, with a 5% interest rate (up from near zero in March 2022) yet to fully impact consumers and businesses. On the other hand, US equity investors are showing signs of a fading risk aversion, indicating that immediate fears of a recession have passed. 

There is much to be optimistic about Mexico’s economy, with some analysts predicting GDP to reach between 2.05% and 2.75%, going up to 3%. However, infrastructure is still a problem, and in 2022 a drought in Nuevo Leon left reservoirs empty. This impacted production for some companies who are still waiting for the promised aqueduct to be built by the government.

The on-going question is whether or not Mexico will see an increase in domestic investment, which will help put the economy on an upward curve of growth. However, some economists are downbeat, saying there will be no real value added locally as Mexico will just continue to import components for assembly then export the final product.

Much of the investment is centred around provinces such as Nuevo Leon, leaving a hefty divide between north and south. The President is determined to bridge this divide and spread the wealth evenly across Mexico. This is Mexico’s big chance to become an on-going success story, let’s hope they grab it with both hands. 

Interest Rates Overview October 2023: United States, Eurozone and United Kingdom 

On the 14th September 2023 the ECB, (European Central Bank), hiked its key interest rate for the 10th time in 14 months to 4%, a record high. The ECB then went on to signal that this was probably going to be the last interest rate rise in the continuing fight against inflation. The ECB (covering 20 countries that share the euro) revised upwards its forecast for inflation, suggesting that it would return to 2% in the coming two years and at the same time revised downwards its forecast for economic growth.

When the ECB changed their monetary policy to quantitative tightening in July 2022, the key interest rate was at a record low of minus 0.5%, which meant that any bank depositing cash had to pay the ECB. Today, after the September 14th rate increase the ECB now pays banks 4% for depositing cash. 

Although the ECB has signalled this is the end of interest hikes, their President Christine Lagarde said interest rates would remain high or restrictive for some time to come, adding that the ECB cannot completely rule out another increase in interest rates even though rates currently stand at their peak.

However, Yannis Stournaras, an ECB Governing Council Member, was quoted as saying, “The ECB as a next move was more likely to lower borrowing costs rather than raise them further”, one of the clearest remarks from the ECB confirming interest rates had probably reached their peak. At the Dutch Central Bank, President Klaas Knot seemed to echo Mr Stournaras’s words that he does not expect any change in the short-term, and added that he expects inflation to return to 2% in 2025.

Indeed, the Vice President of the ECB Luis de Guindos said that he hoped additional quantitative tightening would not be necessary. Furthermore, the Governor of the Croatian National Bank and ECB Council Member Boris Vujcic said that this was probably the last in a long line of monetary tightening. It would appear, therefore, that if inflation moderates the general consensus is that this will be the last in interest rate hikes by the ECB. However, taking a contradictory stance is Bundesbank President Joachim Nagel, who said that as inflation stubbornly remains at 5%, it is too soon to say if rates have peaked. 

The next question is how long will borrowing rates remain high? Investors and economists are already pencilling in spring of 2024 for the first rate cut, especially as the Eurozone economy is showing signs of increasing weakness. Experts advise that the latest increase by the ECB is slowing down the economies in all European countries with a number of central banks advising they will keep rates as high as needed to defeat inflation. 

However, some ECB council members argue that further rate rises may well kill the economy, especially as data shows continuing contraction in services and manufacturing. Indeed, some experts are now predicting a possible recession in the euro area, confirming that economic weakness is not just confined to Germany, which has suffered from high energy prices. 

With regard to Germany, in the week 18th – 22nd September 2023, German bonds fell dramatically which sent the cost of government borrowings to their highest level for 10 years, as investors and traders decided that Eurozone interest rates will remain at an elevated level with the ECB keeping policy tight for some time to come. Indeed, longer maturity bonds were badly hit in a sell-off across Europe, with experts advising that in the short-end debt market investors can achieve returns that are risk free close to circa 4%. 

Meanwhile, across the Atlantic Ocean on 20th September 2023, the US Federal Reserve kept its benchmark interest rate unchanged but at the same time signalling there may be one more interest rate hike in 2023 with borrowing costs staying at an elevated level for longer. The FOMC, (Federal Open Market Committee- the US Central Bank’s policy setting committee), who held rates steady at 5.25 – 5.50%, were quoted as saying, “Officials will determine the extent of additional policy firming that may be appropriate”. After the announcement, yields rose to a decade high on two-, five- and ten-year government bonds as treasuries were sold off. 

Chairman of the Federal Reserve Jerome Powell went on to clarify by releasing a statement saying, “Officials are prepared to raise rates further if appropriate, and we intend to hold policy at a restrictive level until we are confident that inflation is moving down sustainably toward our objective”. He went on to say that we think we are fairly close to where we need to be and that the Federal Reserve is committed to a monetary policy that is sufficiently restrictive to bring inflation down to our goal of 2%.

However, quarterly projections that were updated showed that out of 19 officials in the FOMC, 12 were in favour of another rate hike this year reflecting their desire to ensure the deceleration of inflation. Their projections for the reduction of inflation show that the country will have to wait three years to the end of 2026 where they will see a projected federal fund rate of 2.9%, with the rate being 3.9% at the end of 2025. 

It is interesting to note that traders often take up a contrary position to the Federal Reserve, as when they signal that interest rates will not be dropping anytime in the near future, the financial markets take the opposite view by laying bets to the contrary. These interactions have taken place over the last 18 months, none more so than on the Wednesday during the week 18th September – 22nd September 2023 when the Federal Reserve published forecasts showing that at the end of Q4 2023 benchmark overnight interest rates would be 5.6%, which implies another interest rate rise before Christmas. 

They also announced that their policy rate for the end of Q4 2024 would be at least 5.1%, a full 50 basis points higher than announced three months ago. However, in the financial markets interest rate contracts are continuing to price in a 50/50 chance of increased quantitative tightening in 2023, where they see a 4.65% policy rate by the end of Q4 2024. 

The US economy continues to defy predictions and remains resilient with consumer spending and the labour market remaining steady while core inflation, (all data except for food and energy) has continued a steady decline. However, policymakers will be aware of the 30% increase in oil prices since June of this year plus the resumption in October of the student-loan payments* that will reduce spending power of consumers. They will also be aware of the impending shutdown of the US Federal Government.

*Student-Loan Payments – After a moratorium on Federal student loan payments, these will resume after 3 years in October with interest starting to accrue on 1st September 2023. There are circa 40 Million Americans with federal student debt averaging roughly USD37,000 per borrower. 

Once again politicians cannot agree on the Federal Budget and the government is heading for a shut down in the coming October. Obviously the United States losing the coveted AAA rating and being downgraded to AA+ means nothing to politicians. Government funding shuts down October 1st and a shutdown will effectively begin at 12.01am. This will have a direct impact on the economy, with the travel sector alone expected to lose USD140 Million per day. Some experts predict that economic growth will reduce by 0.2% every week, and the longer the shutdown goes on, there is a bigger probability of interest rates being impacted. It can only be hoped that the hardliners in the Republican Party can come to an agreement with their democratic counterparties. 

Returning across the Atlantic Ocean in London on 21st September 2023, the Bank of England finally brought to a halt (albeit temporary), a highly aggressive cycle of interest rate rises, not seen for 30 years due to signs that the economy may be slipping into recession. Ending 14 successive interest rate rises that started in December 2021, (rates were 0.1%), the Bank of England held their key rate steady at 5.25%. It was a close-run vote with four members of the MPC (Monetary Policy Committee) wanting to raise interest rates to 5.5% and five members voting to leave the rate unchanged along with the Governor (Andrew Bailey) who had the casting vote.

However, as inflation remains three times above the Bank of England target of 2%, they signalled that policy would change if inflation did not fall as expected, with the MPC forecasting that the target would be hit in Q2 2025. Governor Bailey said following the decision, inflation had fallen decisively, but they would continue to take decisions to ensure inflation falls to the target figure. Reiterating its former guidance, the MPC said that interest rates would remain restrictive for a sufficiently long period implying in tandem with other central banks that interest rates will remain high for the time being.

Experts such as economists and investors are already betting on interest rates having peaked, with the pound falling against the dollar, its weakest since March 2023 with currency traders slimming down bets on further interest rate rises. During the week 18th – 22nd of September 2023, experts announced that sterling traded weaker down 4% against the dollar at USD1.2239 the biggest decline across the Group-of-10 Peers* over a period of one month. 

*Group-of-10 Peers – Not to be confused with the G7 or G20, this group consists of Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the United Kingdom, And the United States, (Switzerland enjoys a minor role within this group). This group of countries have agreed to participate in the General Arrangements to Borrow (GAB), which is a supplementary borrowing arrangement that can be invoked if resources from the IMF are estimated to be below a members’ needs, (e.g., to provide more funds for utilisation by the IMF).

It would appear that interest rates have reached their zenith with the Federal Reserve, the Bank of England and the European Central Bank, but with all three suggesting there may or may not be another interest rate hike, rates will stay high certainly for the time being. The Bank of England appears to be the prime candidate to raise interest rates one more time in 2023, with the Federal Reserve a close second with suggestions they may raise rates one more time.  

A US Federal Government Shutdown is Looming

Once again, the Democratic and Republican politicians find themselves in a political arm wrestle over the approval of the federal budget as bitter ideological divisions come to the fore. This is not an unknown phenomenon, as this current deadlock has appeared many times in the past. On the previous occasion, the ratings agency Fitch was moved to reduce the United States sovereign credit rating from AAA to AA+, citing financial mismanagement over the debt ceiling and fiscal incompetence over many years.

Congress is expected to vote to pass 12 appropriation bills that will finance government operations for the start of the new financial year at 12.01am on 1st October 2023, which means the politicians had until midnight on September 30th to iron out their differences. Currently these bills are caught up in the Republican controlled House of Representatives because of demands for deep spending cuts from right-wing congressional republicans also referred to as the far-right “Freedom Caucus”. The good news is that Congress agreed before the deadline to pass a bill officially called HR 5860 that prevents the government going into shutdown. However, this bill only gives enough money to keep the government open for 47 days and was signed into law by President Joe Biden just before the deadline on September 30th, 2023.

The Freedom Caucus is also at odds with their majority leader Kevin McCarthy for agreeing spending limits back in May of this year with the Democratic President Joe Biden, which they feel are far too generous and are in urgent need of pruning. In fact, any bill that is presented to the House is simply refuted by the Freedom Caucus, unless the House gives in to their demands. McCarthy has had five months to bring his rebellious right-wing to heel, but as can be seen by actions in the House, he has failed miserably. However, following a far-right Republican rebellion led by Matt Gaetz and seven Republican representatives and a handful of Democrats, a vote to remove speaker McCarthy was successful. The Freedom Caucus had been incensed for months as the speaker had been agreeing with Democratic spending plans and passing bill HR 5680 was the final straw. 

The Republicans have decided to wait until 12th October 2023 before electing a new speaker, leaving the house rudderless for nearly two weeks, whilst in the meantime the 47 days are counting down to government shutdown. This is exactly the kind of behaviour as cited by the credit rating agencies as to why two out of three have already downgraded the United States’ sovereign credit rating to AA+. However, none of this matters to Congressman Gaetz and his cohorts, who, in their fervour to cut spending, may have single-handedly increased the cost of borrowing for the United States government. 

Previous shutdowns have cost the government literally billions of dollars, as federal workers are sent home as the government grinds to a halt. The misconception is that a shutdown will save taxpayers money, where in reality there is back pay for the thousands of government workers that are sent home, lack of sales from government gift shops and uncollected entrance fees at national parks, to name but a few. The combined cost to the taxpayer for the last three government shutdowns was circa USD4 Billion where some 800,000 federal employees are sent home. In 2019 a report by the Senate Homeland Security and Government Affairs Committee on government shutdowns for 2014, 2018 and 2019 showed that out of circa USD4 Billion, that USD338 Million went on various fees, including administrative work, late fees on interest payments, while USD3.7 Billion was paid in back pay to those workers who were sent home. 

There are many government departments and areas that are affected by a shutdown as listed below.

  1. White House

During the last shutdown the Whitehouse furloughed about 60% of their staff within the President’s Executive Office and, whilst the National Security Council continued to run normally, other areas such as the OMB, Office of Management and Budget found themselves working with a skeleton staff.

  1. Agriculture

 Rural development, conservation and research programmes would be shut down, and some laboratory services would be closed making the fight against animal disease more difficult.

  1. Small Business Support

 Loans for small businesses would halt as the Small Business Administration would stop operations except for those businesses hurt by natural disasters.

  1. Labour Market

Investigations into unfair pay practices would halt and safety inspections in the workplace would be severely curtailed.

  1. Education

Most Department of Education employees would be sent home for th duration which could mean disruption to student loans and Pell Grants*.

*Pell Grants – these are needed based federal grants/aid for students in post-secondary education or college and differ from student loans as they very rarely have to be repaid.

  1. Economic Data

According to the current administration the publication of major US economic data would be suspended, this would include inflation and employment data which is of major importance to investors and policy makers. 

  1. Health

The CDC (Centre for Disease Control) would have over 50% of their workforce sent home though many public health activities would suffer though they would continue to monitor disease outbreaks. 

  1. Transportation

Contingency plans for a shutdown allows for air traffic controllers to keep working, although history shows absenteeism could be a problem. Experts suggest that the travel sector alone will lose USD140 Million per day.

  1. Science

The National Science Foundation, the National Institutes of Health and the NOAA, (The National Oceanographic and Atmospheric Administration) would send home most of their staff curtailing scientific research.

  1. Financial Regulation 

Out of its 4,600 staff The Securities and Exchange Commission would send home circa 90% with only a skeleton staff available to deal with emergencies. Furthermore, the CFTC (Commodities and Futures Trading Commission) would also send home most of their staff, thereby halting regulation, enforcement and oversight. 

  1. Social Security, Medicare and Other Benefits 

Circa seven million mothers who receive nutritional benefits via the Woman Infants and Children Programme would cease to receive such benefits. The Supplemental Nutrition Assistance Programme would continue to provide food benefits throughout October, but come November distribution could be affected.

  1. Disaster Response 

There is the potential for FEMA (The Federal Emergency Management Agency) to run out of funding for long-term recovery projects and disaster relief. 

Experts are also warning that a government shutdown would spook the financial markets with some analysts predicting that economic growth would be reduced by 0.2% for every week it lasted. However, it is important to note that history shows that government shutdowns are only very short-term and investors worrying about economic uncertainty should satisfy themselves that any shutdown will only be temporary.

Another investor worry is how will the US Treasury market (government bonds) fare under a shutdown? Taking a look at the Move Index*, historical data shows market volatility rose by 3.8% during the government shutdown of 1990 and rose by 7.2% during the government shutdown of 1995 – 1996. However, during the shutdowns of 2013 and 2018 – 2019 market volatility fell by 12.6% and 14.8% respectively.

*Move Index – is a market implied measure of bond market volatility. The calculation of implied volatility is based on US Treasury Options utilising a weighted average of option prices on Treasury Futures across multiple maturities being 2,5,10 and 30 years. 

Historically, there has been a negative impact on US stock markets during government shutdowns which should calm any nerves of equity investors. In fact, data shows that the S&P 500 Index gained an average of 4.4% during such shutdowns. Experts suggest that investors should look for bargains in the healthcare and defence sectors, which depend greatly on contracts from the government. Such suggestions are due to the fact that both sectors are currently underperforming in the S&P 500 and buying opportunities may well present themselves in the event of a shutdown. Historical data show that since 1995, during shutdowns the defence sector and the healthcare sector advanced 5.2% and 2.3% respectively, and in the longer term both could benefit from government spending. 

Out of the big three credit rating agencies, Standard and Poor’s*, Moody’s and Fitch, the only credit rating agency that still gives the United States a AAA Sovereign Credit Rating is Moody’s (Aaa equivalent). However, since Fitch downgraded the United States Sovereign Credit Rating from AAA to AA+ (1st August 2023) due to the debt ceiling crisis, Moody’s have announced that a government shutdown would negatively affect the country’s credit rating. 

In early August 2011, Standard and Poor’s downgraded the United States Sovereign Credit Rating from AAA to AA+ which followed an acrimonious and bitter debate in congress regarding national debt. They went on to say that the budget deal that was brokered between the Republicans and the Democrats did not do enough to address the gloomy outlook for the US finances.

Moody’s analyst William Foster recently advised that current evidence shows political polarisation is making policymaking in Washington DC weaker due to higher interest rates putting pressure on government debt affordability. A government shutdown would further enhance this evidence. Mr Foster went on to say “If there is not an effective fiscal policy response to try and offset those pressures … then the likelihood of that having an increasingly negative impact on the credit profile will be there, and that could lead to a negative outlook, potentially a downgrade at some point, if those pressures are not addressed.

The upshot is that due to the usual political machinations, the United States may well lose their last coveted AAA sovereign rating, (Moody’s Aaa), and the country may perhaps look less creditworthy and could be looking at paying higher interest on their debt. Indeed, updated costs on the shutdown from experts estimate that the cost to the US economy could be in the region of USD6 Billion per week. 

If bill HR 5860 had not been passed, the Federal Reserve would have had to fly blind without any data especially as employment and inflation data is due in early October, data that has an impact on interest rates. Thankfully, the Federal Reserve will receive this data, but once again the elected officials are doing their best to make it difficult for the unelected officials or experts to run the economy of the country, and do not think for one minute that a new Speaker of the House will bring the curtain down on continuing arguments over the federal budget. Matt Gaetz and his pals in the far right Freedom Caucus will continue to fight for spending cuts unless the Democrats at least begin to try and meet some of their demands.