2023.09.28 08:16
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Interest rates in the United States are soaring! Wall Street is already drawing parallels to 2008: we are now in 2007.

JPMorgan: "At the beginning of 2007, the market accepted the view of a soft landing, with steady economic growth; corporate profit growth slowed down but did not collapse; inflationary pressures eased but did not disappear - if you haven't noticed, this is the situation we are currently in."

The Federal Reserve has turned hawkish, and the high interest rate environment continues. The yield on the 10-year US Treasury bond has soared, and Wall Street analysts have caught a "familiar scent."

The US federal benchmark interest rate has risen to its highest level since 2001, ranging from 5.25% to 5.5%. Since Federal Reserve officials made it clear last week that interest rates may remain at higher levels for a long time, the yield on the 10-year Treasury bond has also reached its highest level since 2007.

This means that the market has shifted from betting on a soft landing for the US economy to considering the possibility of an economic recession.

Some people on Wall Street have started to feel uneasy. Morgan Stanley analyst Marko Kolanovic exclaimed in his report that the current situation is "similar to 2008."

In early 2007, the market accepted the view of a soft landing, with steady economic growth, gradual stabilization of the housing sector, a slowdown in corporate profit growth but no collapse, and easing inflationary pressures that did not disappear.

If you haven't noticed, this is the situation we are in now.

Although the S&P 500 index has continued to rise this year, he believes that this is only due to the boost from large companies that have risen due to artificial intelligence:

Perhaps a better way to measure macro fundamentals is through equal-weighted indices such as the S&P 500 or small-cap indices, which have performed flat this year and have not performed as well as cash (federal funds).

What will happen next?

Kolanovic said that their conclusion still points to "macro fundamentals facing challenges and risk assets facing headwinds."

This reasoning is based on fundamentals, investor positions, and various macro and geopolitical considerations.

2023 VS. 2007

Kolanovic cited Morgan Stanley's US market strategy report from 2007 and believes that the current market sentiment may be similar to the early 2007.

During the previous rate hike cycle and afterwards, Kolanovic divided the economy into three stages:

Stage 1:

On June 30, 2006, the Federal Reserve completed the last rate hike of the rate hike cycle, raising the federal funds rate to 5.25% (similar to the current situation).

The Federal Reserve officially paused rate hikes at the August FOMC meeting, and risk assets began to rise strongly, which continued until early 2007.

However, due to a total of 425 basis points of rate hikes in the previous two years, the economy clearly slowed down, with GDP declining from 5.6% in the first quarter of 2006 to 2% in the third quarter of 2006.

Analysts said that the market consensus at that time was "rapid economic slowdown, sharp decline in housing, and the Federal Reserve will start cutting interest rates." However, subsequent data showed the "resilience" of the US economy, dispelling market expectations of a recession.

Phase 2:

December 2006 to January 2007. The strong December non-farm payroll report raised doubts about the potential strength of the economy, but subsequent economic data for the remainder of December 2006 and January 2007 showed that the economy was shaking off the impact of high interest rates and high commodity prices.

Market participants gave up hope for interest rate cuts and accepted the view that the Federal Reserve had achieved a soft landing, and agreed that the Goldilocks economy (stable economic growth, moderate inflation, low unemployment) was taking shape.

Economic growth was steady, at around 3%, driven by a resurgent consumer; the housing sector was gradually stabilizing; corporate profit growth slowed but did not collapse; inflationary pressures eased but did not disappear. Risk assets traded at full value, staying within a narrow range of low volatility.

We call this phase a "false move" - everything feels too good because it is.

If you haven't noticed, this is where we are now.

However, inflation also showed resilience, and although the Federal Reserve paused its rate hikes, there were no signs of a dovish turn, but rather continued hawkish rhetoric:

Phase 3:

June to October 2007. Inflationary pressures continued to exist as healthy economic growth put increasing pressure on the labor market and utilization rates.

Market participants now began to painfully realize that the Federal Reserve might be forced to raise interest rates to curb inflation.

However, before taking any rate hike measures, the Federal Reserve would increase its hawkish rhetoric to prepare the market. Some investors would take note of this and reduce risk, while others would see the Fed's threats as empty and stubbornly insist that the housing market, consumers, and high leverage in the system would be legitimate reasons for the Fed to postpone rate hikes.

Risk appetite declined, sentiment worsened, and valuations of risk assets corrected.

In October 2007, US stocks began a large-scale decline. The S&P 500 index fell over 57% from October 2007 to March 2009, marking the largest decline in 70 years.

Kolanovic stated that if concerns about economic growth continue to diminish while concerns about inflation steadily rise, risk takers should anticipate the "valuation instability phase" caused by the Federal Reserve's determination to control inflationary pressures within its defined target range.

Our best guess is that such a phase may occur later this year, possibly in the third quarter.