Whirlpools and Whirlwinds
The S&P is now up for the year. Which is pretty much what one would expect against the backdrop of the World Bank calling a deep global recession, the worst US economic downturn since the 1930s, and the worst civil unrest since 1968. Regardless, companies with no income but cool names are up. Openly bankrupt firms are being panic bid. Retail money is pouring in to the market; risk parity funds are pouring in too as volatility comes down; and market shorts have largely been covered, while soon we will get the next leg-up as we actually go long.
This Daily is not equity-focused, but a few comments on this. Rabo’s own Christian Lawrence mused to me recently that we only need to expect equities to follow fundamentals if equity investors actually care about fundamentals – and it is clear they currently don’t.
The bond market is traditionally serious, but has been made increasingly frivolous by central-bank interventions. FX markets, riddled with day-traders as they are, still have some major players buying and selling in line with the underlying physical economy. By contrast, if everyone is holding stocks just to pass on to the next greater fool, and if the greatest fool is a central bank with infinite liquidity to buy them, then, yes, prices will keep going up.
Indeed, just look at the Fed’s new expansion of its Main Street Lending Programme. This now has a lower minimum and higher maximum loan size, can be for up to five years, and with no repayments for two years, with no interest for the first year, and set at LIBOR plus 300bp: banks must hold 5% of the loan, and the Fed holds the remaining 95%. Isn’t this good for the economy? Perhaps. Yet as a fellow bear/cynic noted to me today, if one was a struggling US SME facing a recession, why not take out one of these loans and go long the S&P with it? If things work out in the markets this will provide a cushion for the struggle coming in the real economy; if the market crashes it means you were economically dead anyway. In effect it’s a free option 95% covered by the Fed.
We are all Keynesians now, of course, and central bankers certainly see themselves that way. Yet as the man himself said almost a century ago in The General Theory of Employment, Interest and Money: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.” I don’t think enterprise is even the bubble now: it’s not even necessary in some cases.
Likewise, allow me to paraphrase how someone else on Twitter put it when speaking for the central banks: “First we have to buy the junk bonds. Then the people who sell the junk bonds buy stocks with the money. Then those who own stocks buy USD1m bananas taped to the wall. And then the money flows down to the little guys.”
Meanwhile, the USD is also on the retreat and is pretty much back where it was in January, mirroring what the S&P is done in the other direction. Stephen Roach, now teaching at Yale, has a Bloomberg opinion piece out today arguing that a Dollar crash is looming as its “exorbitant privilege” comes to an end. American exceptionalism is being questioned, he says. The US is not saving enough. The current-account deficit is set to soar alongside the fiscal deficit. Trump’s protectionism and America First policies like leaving the WHO will cut off global capital inflows and make the USD fall faster, and it could slump 35% on a trade-weighted basis. This would be inflationary, and rates would need to rise. I do hope that Mr Roach’s course at Yale covers a lot of Keynes and less of this milquetoast analysis.
American exceptionalism is being questioned, yes; just as it has been for years – who is NOT being questioned at the moment? The US is not saving enough: it never really does, but that is the function of the exceptionalism of a global reserve currency! Foreigners demand it and you must supply it by dis-saving.
Yes, the US current account deficit is set to soar, partly due to the mercantilism we already see in China and others in response to this downturn --which is testing everyone-- and partly due to the enormous increase in the US fiscal deficit. Would the world be better off if the US government was NOT running a deficit and the private sector saved more at the same time, thrusting the US into fiscal and current-account surpluses? Can you begin to imagine the economic wreckage that would result domestically and internationally?
Moreover, the US does not need foreign capital inflows to cover its deficits when the Fed is buying the bonds issued: there was net foreign Treasury selling during the March panic – and yet US and global bond yields collapsed. This week the Fed might even introduce yield curve control for goodness sake! There is no risk of an increase in US interest rates as far as the eye can see.
So might the USD fall 35% trade-weighted? When one looks at the speculation-based economy, vast deficits, frenetic Fed activity, and low yields one might say yes…except that everyone else is in the same boat or worse. Everyone is seeing vast fiscal deficits, state intervention, major QE, and/or yield curve control. An ECB member was openly saying “Never say never” about buying stocks just yesterday, for example; and the laissez-faire Hong Kong government has just announced it is bailing out Cathay Pacific to the tune of HKD30bn. Yes, supply of USD is soaring – because it was demanded globally: and now the supply of all other currencies is about to match it with a lag.
Yet NOBODY else’s currency has a global function that can replicate that of the USD. Indeed, as dollar debt has soared again, so has the future demand on dollars to repay it. That is why on the ‘America First’ issue, every time we have seen a breakdown in US-China trade relations the market move has been to a higher USD and lower CNY (and other EM FX), both from a risk-off perspective and precisely because US protectionism and domestic money printing means ‘more USD for me and none for thee’. The shoe is going to drop here again soon on the current political trend.
What we are seeing in USD at the moment is simply the reversal of the panic-driven rush to hold greenbacks when the world looked like it was falling apart. Guess what? The world is STILL falling apart – it’s just that liquidity-driven markets are focusing on Keynesian “whirlpools of speculation” and not the coming whirlwind.
Michael Every is the Head of Financial Markets Research Asia-Pacific. Based in Hong Kong, he analyses the major developments in the Asia-Pacific region and contributes to the bank’s various economic research publications for internal and external customers and to the media.
Michael has nearly two decades of experience working as an Economist and Strategist. Before Rabobank, he was a Director at Silk Road Associates, a strategy consultancy based in Bangkok. Prior to this, he was Senior Economist and Fixed Income Strategist at the Royal Bank of Canada based in both London and Sydney. Michael was formerly also an Economist for Dun & Bradstreet in London, covering ASEAN.
Michael holds a Masters degree in Economics (with distinction) from University College London and speaks Thai.
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