“This Is The Tipping Point”: One Bank Is Calling For A 30% Market Correction

Wednesday, October 10, 2018
By Paul Martin

by Tyler Durden
Wed, 10/10/2018

While some believe that it is the level (or stock) of the 10Y yield during a rate rout that determines the resulting revulsion toward equities, while others claim that it it speed of the sell off (the “flow” angle) that matters, the reality is that the higher rates rise – whether fast or slow – the less attractive risk assets become (in a recent analysis, Bank of America calculated what the great un-rotation “magic number” is for yields).

And while violent repricings certainly have an impact on risk assets – if only over the short-term, until rate vol normalizes – as today’s market action confirms, a more comprehensive theory suggests that the US dollar (the world’s reserve currency) and US interest-rates (world’s risk-free-rate) cycle play a vital role in determining changes in asset prices and the global economy, especially after the gold standard was abolished in 1971.

In a new note from Nedbank’s Neels Heyneke and Mehul Daya, the strategists explain why they believe “we are approaching historical thresholds”, where tighter monetary conditions in the US have traditionally been the “straw that breaks the camel’s back” for the equity market and economic growth, and why “this time should be no different.”

To begin, Nedbank defines US real interest rate as the spread between the US 10-year bond yield and the natural rate of interest (r*). The Laubach-Williams r* estimate is basically the real short-term interest rate at which the US economy is at equilibrium, i.e., where unemployment and inflation are at the 2% target. This allows to determination of monetary conditions in the US relative to the underlying economy.

Historically, US real interest rates have been an accurate indicator for measuring monetary conditions and gauging turning points in the financial and economic cycle. During the “Volker era”, US real interest rates rose steadily and ranged from 4-10%. However, from the late 1990s, it has become evident that central banks would bail out the financial system (Greenspan/Bernanke put) and, as a result, US real interest rates have ranged from 1-3%. Since the late 1990s, it has also been quite evident that when US real interest rates rise to the upper band of the 1-3% range, monetary conditions become too tight, leading to a liquidity crunch in financial markets, marking the end of the economic cycle.

The Rest…HERE

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