The ISM manufacturing new orders index dropped to 44.3 in March. The Treasury market is telling the Fed to cut rates this year, to prevent a further deterioration in credit conditions. It remains to be seen which way the Fed will sway.
The latest Dallas Fed Banking Conditions Survey (data collected March 21-29) portends tighter bank lending standards across the US. But the aggregate interest coverage ratio (ICR) for domestic non-financial corporates continues to climb. Net interest & miscellaneous payments continue to fall.
It could be that companies are much more resilient to interest rate rises, having locked in lower funding costs for longer. In this case, the Fed may require even larger rate rises to slow the economy.
At the same time, the aggregate interest coverage ratio may be hiding stresses that are emerging in junk-rated companies and leveraged loans. There is a yawning chasm between tightening bank lending standards, and the rally in high yield bonds and technology stocks.
Treasuries are at the beginning of what could be a long, drawn-out bear market. A rate cutting cycle will not be as deep as in 2007/08. The global backdrop is very different. The world is deglobalizing. There are limits to offshoring. Labour shortages are deeply entrenched, tipping the scales back (albeit moderately) towards workers. China controls clean energy supply chains. And OPEC+ is back in charge of oil prices. Commodities markets may be heading for a renewed bout of volatility. In such an environment, the term premium on government bonds should be much higher.
