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  • The remarkable performance of risk assets in 2023 is not primarily due to the growing likelihood of a soft landing
  • It instead reflects markets being buffeted by extraordinary amounts of central bank liquidity
  • For now, those technicals remain positive, but beyond Q1 they should fade or reverse
  • Underlying momentum in growth, earnings and inflation - beyond sticky supply-side effects - is significantly weaker
  • Hark! The VC angels sing
  • God rest ye, merry crypto bros
  • While PMs watched tech stocks take flight
  • I'm dreaming of a tight market
  • To be sung, please, in a spirit of global harmony
  • The biggest surprise of 2023 was not the resilience of the US consumer
  • It was that central banks added nearly $1tn in liquidity, rather than removing $1tn as had been widely expected.
  • This swing alone is worth 20% on equities - almost exactly the YTD gain in the S&P.
  • We think 2024 will show central banks have overtightened rates whilst simultaneously overstimulating risk assets.
  • But we also fear their misunderstanding of the dynamics means they may yet do more of both.
  • The rally does not reflect the likelihood of a soft landing
  • It is the direct consequence of a surge in Fed liquidity
  • Widespread misunderstanding of these dynamics increases the likelihood of more rate rises and a harder landing later
  • Poor risk asset performance in Sep/Oct reduces gap to CB liquidity
  • Fed $300bn reserve increase over past eight weeks helps explain renewed rally in S&P
  • Conversely, despite talk of stimulus, China liquidity injections remain lacklustre
  • Liquidity outlook still driven by RRP - and is much less negative than might be expected
  • Persistent fiscal deficits are increasingly cited as the #1 reason to short bonds
  • But the historical record is remarkably and perplexingly clear
  • High debt levels, and even high fiscal deficits, have historically been associated with bond yields falling, not rising
  • Only in part does this reflect factors like financial repression
  • It is also due to the counterintuitive nature of the credit creation process itself
  • Is the mini-correction in markets a foretaste of something bigger, or does the still-strong real economy give risk assets scope to bounce back?
  • Should investors be rotating out of equities and into bonds, or are the latter still vulnerable to buyers' strikes against a backdrop of fiscal indiscipline?
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  • It's not just a stronger economy
  • Nor even those long and variable lags
  • It's that markets are being driven by money flows and not rate levels
  • It is often said that QE held down bond yields, meaning QT should be a major contributor to this year's rise
  • But the evidence for this is deeply questionable
  • QE does indeed hold down real yields, through a portfolio balance effect
  • But it also pushes up inflation breakevens via signalling
  • What is missing so far from this round of QT is the historical fall in breakevens
  • The true driver of higher bond yields lies with inflation, not QT
  • CB liquidity still a better explanation of risk asset performance than many fundamentals
  • H1 liquidity injections now fading
  • Market performance - despite some prior 'excess' - largely fading in line
  • Prospects mostly negative but depend on RRP, BoJ and explanation for the prior 'excess'

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