By now, it’s a very familiar question: how high can the Fed hike rates before it causes a major market “event.”

Two weeks ago, Stifel analyst Barry Banister became the latest to issue a timeline on how many more rate hikes the Fed can push through before the market is finally impacted. According to his calculations, just two more rate hikes would put the central bank above the neutral rate – the interest rate that neither stimulates nor holds back the economy. The Fed’s long-term projection of its policy rate has risen from 2.8% at the end of 2017 to 2.9% in June. As the following chart, every time this has happened, a bear market has inevitably followed.

A similar argument was made recently by both Deutsche Bank and Bank of America, which in two parallel analyses observed last year that every Fed tightening cycle tends to end in a crisis.

Now, it’s the turn of BCA research to warn that ultimately the fate of risk assets depends on the relative size of the inflationary impulse being spawned by the Fed vs the remnant disinflationary impulse from monetary policies over the past decade.

In a report issued on Friday, BCA’s strategists make the key point that the performance of bonds – and stocks – in an inflation scare would depend on the relative size of the inflationary impulse compared with the disinflationary impulse that resulted from sharply lower risk-asset prices.

They make the point that if central banks were more concerned about the inflationary impulse, which at least for Fed chair Powell appears to be the case for now – Janet Yellen’s “lower for longer revised forward guidance” notwithstanding – they would have to keep tightening – in which case, bond yields would be liberated to reach elevated territory. Conversely, if the bigger worry was the disinflationary impulse, which arguably is the case from a legacy standpoint, central banks would quickly reverse course, and bond yields would return to the lowlands. Thus, the disinflationary impulse from lower risk-asset prices would end up as the bigger issue.

BCA then goes on to note that the current episode of elevated risk-asset valuations is not unprecedented, but there is a crucial difference today with past experiences. Previous episodes of elevated risk-asset valuations tended to be localized, either by geography or sector: 1990 was focused in Japan; 2000 was focused in the dot-com related sectors; 2008 was focused in the U.S. mortgage and credit markets and preceded the emerging market credit boom.

By comparison, BCA warns – echoing a point made here on numerous occasions – the post-2008 global experiment with quantitative easing, and zero and negative interest rate policies have boosted the valuations of all risk-assets across all geographies and all asset-classes – global equities (see chart), global credit, and global real estate. The “bubble in everything” as some call it.

This broader overvaluation makes things “considerably more dangerous” for investors, as BCA estimates that the total value of global risk-assets is $400 trillion, equal to about five times the size of the global economy.

The takeaway is that any inflationary impulse would – through higher bond yields – undermine the valuation support of global risk-assets that are worth several times the size of the global economy. Thereby, it could unleash a potentially much larger disinflationary impulse. Or stated simply, the higher yields go, the lower they will eventually drop during what Albert Edwards has dubbed the next deflationary “ice age.”

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