Debt-saturated markets may soon face a ‘Minsky’ moment

It’s part of a pattern where every adversity is met with a shrug of the shoulders, and “oh well, it could have been worse” insouciance. Even the oil price failed to react.

Even so, things look poisonous enough; what hitherto had seemed a relatively contained, if horrific, conflict now shows every sign of turning into a wider regional conflagration, perilously drawing in Israel’s Western allies.

It’s possible – now that “honour” has been satisfied – that things will settle back into the uneasy standoff that presided before last weekend’s drone and missile attacks.

Neither Israel nor Iran have any real interest in widening the conflict; they don’t want outright war, and nor do Israel’s allies. Everyone is scrambling to prevent it.

Yet the risk of matters spiralling out of control is high.

It all looked so different just a week ago. Central banks had seemingly pulled off the impossible in engineering an economic soft landing. The inflationary pressures of the past two years appeared to be abating fast, and both households and businesses seemed to be coping well with still high interest rates.

Last year’s banking turmoil, moreover, was well contained, with little evidence of wider systemic damage.

All good then. Normally, a monetary tightening of the speed and size of the one applied over the last two years would have resulted in a significant recession.

It’s true that there have been mild, technical recessions in a number of economies, including the UK, but there’s been virtually no rise in unemployment, and growth is now returning, albeit in stubbornly subdued form. As for the US, it hasn’t even flirted with recession, and is now growing in a way which is the envy of the world.

Yet the absence of a more significant economic correction has left financial markets badly exposed, with stretched valuations – particularly in tech related stocks – and narrowing spreads that pay scant regard for underlying credit risks.

There is little or no room for further shocks or policy errors. Well now we have two of them in short order – a sudden ramping up in geopolitical tensions, and a pronounced shift in the expected trajectory of inflation and therefore interest rates.

Lots of households, businesses and property developers were banking on a steep fall in interest rates to dig them out of a hole.

This now looks likely to happen more slowly than anticipated. Many will struggle to refinance themselves on reasonable terms.

And that’ll especially be the case if energy prices spike anew, as seems possible given the turn of events in the Middle East. Higher than anticipated inflation will keep rates higher for longer, punishing the highly indebted, including governments already teetering on the brink of fiscal crisis.

In any case, the anticipated soft landing may turn out to be just another case of wishful thinking.

Sell in May and go away, says the old stock market adage. Maybe that should be brought forward a week or two this time around.

The Telegraph, London

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