The global economy is experiencing a tectonic shift — from a lack of demand (requiring stimulus) to a lack of supply (requiring suppression of demand).
The sharp rise in interest rates is just part of the adjustment to the new reality.
The rise in short-term rates did not have much impact on consumer spending. Personal Consumption is still above pre-pandemic levels relative to disposable personal income, while the savings rate has fallen to almost half of pre-pandemic levels.
High prices are the cure for high prices
The bond market and oil markets are now testing the assumption that the economy can cope with high interest rates and pull off a soft landing.
Two key prices — long-term interest rates and crude oil — are rising. This is likely to cause a strong contraction.
Mortgage rates (7.49% for 30-year) are at their highest level in more than 20 years.
Corporate debt more than doubled relative to GDP since the 1980s, as corporations took advantage of cheap debt. When they roll over borrowings, they are now confronted with a sharp increase in debt servicing costs, forcing them to de-leverage.
Telecommunications Sector
The impact is clearly visible on sectors with high debt levels — like telecommunications, utilities, and real estate. The chart below compares performance of major telecommunications companies.
Only Orange (FNCTF), the French national carrier, has held its value since the start of 2022. Some, like Telstra (TLS) and Vodafone (VOD), succeeded in reducing debt by selling key assets (e.g. mobile phone towers) into a separate infrastructure trust. Spanish carrier Telefonica (TEFOF) has also done reasonably well, selling off some international interests. Many — notably Verizon (VZ), AT&T (T), Vodafone (VOD), and BT Group (BT) — have lost 40% of value in less than two years. Belgian carrier Proxima (BGAOF) gets the wooden spoon with a 60% loss.
Further adjustment will be necessary as the recent rise in long-term interest rates forces corporations to rein in capital expenditure and shed non-core assets in order to reduce debt exposure. That in turn impacts on equipment manufacturers like Ericsson (ERIC) and Nokia (NOK).
Conclusion
Rising long-term interest rates and crude oil prices are likely to cause a global economic contraction.
Sectors with high debt levels — like telecommunications, utilities, and real estate — will be forced to restructure due to rising interest rates. This is likely to have a domino effect on other sectors of the economy.
Acknowledgements
- Mohamed El-Erian: The US may no longer avoid recession
