Kikis Lagos: “Negative developments have followed a number of long standing recession signals”

“Global asset prices have plunged recently while safe havens including safe government bonds have rallied in a classic risk off phase,” Kikis Lagos, Managing Director, One Plus Capital Ltd suggests.

He was speaking to CBN after being asked to comment on the recent developments in the global markets.

"There are two main reasons behind this risk off phase. The first is rising worries that the US economy is heading to recession following a weaker-than-expected pay rolls report last week, rising unemployment and the triggering of some recession signals. These negative developments have followed a number of long standing recession signals such as the inverted US yield curve. As the US economy was one of main pillars supporting global growth, a US recession will also increase the risk of a global recession," he continued.

Lagos went on to say, “The second reason behind the sell-off is tighter monetary policy by the Bank of Japan, resulting in more upward pressure on Japanese interest rates and a stronger yen. Consequently, is has become more attractive for (Japanese) investors to bring capital (back) to Japan, increasing the upward pressure on the yen further. As many investors have borrowed yen to purchase assets in higher yielding currencies, a stronger yen means these so called ‘carry trades’ are incurring losses, leading to unwinding of these carry trades and hence selling of all sorts of assets and buying of yen, resulting in a self-feeding spiral.”

According to the Managing Director, “Both developments could be strong enough to break the bull market since corona and turn it into a bear market, with investors realizing that asset price valuations have risen too far given the rising fear of recession, the high political risks and less enthusiasm about the outlook for the productivity and profit enhancing capabilities of Artificial Intelligence.”

“Furthermore, declining asset prices could contribute to US recession worries if consumers see their net worth declining and become more cautious to spend money. In addition, falling asset prices will give rise to more worries about Private Equity and the risk it poses to financial stability. Lastly, fiscal authorities have very limited possibilities to provide a strong fiscal boost to economic growth, given the already very high government deficits and debt levels,” he continued, before noting, “However, there are a number of reasons to expect the recent plunge in asset prices is part of a correction which could be followed with quite a strong recovery, if not a rise to new highs: First, given the high debt levels and the limited ability to stimulate the economy fiscally and (as long as inflation remains relatively high) monetarily, a negative spiral will quickly entail the risk of the debts weighing too heavily on the economy, potentially triggering a credit crisis.”

As Lagos underlined, “The best strategy for monetary authorities is to avoid such a negative spiral. This is why central banks likely won’t hesitate long to ease monetary policy significantly. Second, with US growth outlook deteriorating, the main Chinese growth engine (exports) is at risk of losing steam, increasing the risk of more downward pressure on Chinese growth and more problems with too high local government debt levels. Consequently, the pressure on Chinese officials is increasing to stimulate economic growth a lot more.”