September 2024

The interest yield curve inverted in July 2022 and has continued until today, the most prolonged period in history. An inverted yield curve implies that the short-term interest rate is higher than the long-term interest rate, and it is normally a sign that a recession is coming. But where is the Recession in the USA? Since the dollar was taken off the Gold Standard in 1971, there had always been a positive real Fed fund rate - i.e. Fed funds

rate less inflation. However, between 2002 and 2022, there was a negative real interest rate for 20 years. There have been times when the effective real Fed fund rate has increased as high as -8%. The US raised interest rates from March 2022 to July 2023 11 times from 0.5% to 5.5% - and that increased the short-term interest rates (which are affected by the Federal Reserve) and not so much long-term interest rates as there is not so much demand for it.

The cheap funds for 20 years caused a Triumvirate of bubbles: a Real estate bubble, an Equity bubble, and a Credit bubble.

• Real Estate prices are the highest they have ever been compared to income earned. Hence, they have become unaffordable for first-time buyers. Even upgrading is not happening because how can someone with a mortgage of 3% go out and buy a new house with a mortgage of 7%? • Credit Non-financial debt to GDP is higher than during the subprime crisis. The market has already priced in rate cuts, which is why the 10-year GSec yield is 3.9%, with the Fed rate at 5.5%. Total household debt is US $17.8 tn, out of which the very expensive last-resort credit card debt is US$1.14 tn. Private Credit is at an all-time high, US$1.7 tn, and did not exist a few years ago.

• Equity market cap to GDP is about 200% now. In 1929 and 2007, it was a little more than 100%. Even the Dotcom bubble was 138%. It has never been seen at this level. Hence, although the Federal Reserve raised interest rates, the expected correction has not yet occurred. 2000 - The tech bubble burst - and the equity market fell 2008 - The Real Estate bubble burst - and the equity market fell

The following could be reasons for delay in the expected US Recession

• The Federal Reserve has been raising interest rates and trying to reduce its Balance Sheet by selling bonds instead of buying new ones. This was expected to reduce the money supply in the economy, cut inflation, and deflate the bubbles. • However, US Government spending is increasing. The US government deficit in 2024 is expected to be US$2 tn. Most of the GDP growth has been attributed to Government spending, which has been financed by Short-Term Treasury Bills, where the yield that the government has to pay is over 5%+. The annual interest bill has gone over US$1 tn, which, in effect, puts money into the economy, along with the short-term issuance of Treasury Bills. So, while liquidity was being taken out - it was simultaneously put in again. It is like driving a car by accelerating and braking together. • The rapid increase in interest rates caused stress on the banks holding government securities because rising rates meant a fall in the value of the bonds, and hence, there were losses. Silicon Valley Bank, Signature Bank, and First Republic Bank were in trouble in 2023 and were, in effect, bailed out by the Federal Reserve taking over the bonds at par. This is once again keeping the liquidity going, and hence, the bubbles were maintained. • A recession in the US was impossible when schemes from Pandemic sops, such as Mortgage Forbearance, Paycheck Protection Scheme, Employee Retention Credit, and economic disaster loans after payout onwards of US$1.5 tn, were still in place; they only stopped in September 2023.

• Unemployment figures are still in the normal range of about 4.3%. However, inflation has caused prices to go up over 25% in the last four years, and inflation is still at 3%, i.e., still going up although at a slower rate. Further, the inflation calculation does not include food, energy, and taxes. Wages have not increased at the same rate in the last four years. Hence, the middle class is struggling to make ends meet The Federal Reserve is expected to start cutting interest rates in September 2024. Jerome Powell claimed it was time to concentrate more on employment as the inflation target had been reached. This will cause the dollar to fall—which has already started in anticipation of the interest rate cut—and is suitable for emerging markets. If the dollar does remain strong, it would mean that the currencies of the rest of the world are in a worse state, and there continues to be a flight to safety. A 25 bps rate cut is expected. If the cut is 50 bps, it may signal that the situation is worse than anticipated. So we will have to see whether it will be a soft landing or a Recession, as history has shown that there is a Recession in most cases after a pivot. If the bubbles in the US burst, India, too, will be affected and corrected. But India is one of the few countries in the world with good macros, and with our favourable demographics, it will likely stay that way for the next decade. Hence, any correction would be an opportunity to buy at more reasonable prices.

EQUITY MARKET

The Indian stock market's valuations are not cheap. Return expectations have to moderate a bit. Stock-picking skills will become more important going forward.

DEBT MARKET

Global central bank action is not currently synchronised. Japan is raising rates while Canada is cutting interest rates. So, each country will do what is in its own interest. Our 10-year G Sec rates are drifting slowly lower, but there has been no official cut yet.

GOLD & SILVER MARKETS

Falling interest rates and a weakening dollar are both favourable for Gold.