The global economy has never before dealt with such astronomical levels of debt

I was yesterday cleaning up my mailbox when I tripped over and deleted an incoming mail titled something along the lines of “Have stocks got it right and bonds wrong?”. I now wish I’d read it before wiping it because, for fun, I’d have loved to have checked out the writer’s arguments. I don’t know who wrote it and can’t remember for whom, but Financial Journalism 1.0.1 should teach that stocks getting it right and bonds getting it wrong just doesn’t happen. As I have tried to explain, and most probably will die doing so, stocks trade on hopes and aspirations and bonds on facts and the here and now. And so it is that we are where we are.

Since the back end of last week, US markets are obsessed with the idea that the Fed is close to taking its foot off the gas and that although we are still a goodly way away from the high watermark in the current tightening cycle, the horizon might be in sight. The optimism, just to put a number on it, is that after an impending increase in the rate of Fed Funds on November 2nd, currently at 2.25%-2.50%, by 75 bps, the next one will not be for another 75 bps but only for 50 bps. Markets have spent months trying to second guess where the cycle will end – the latest catchphrase is “Terminal Rate” – but how that can be sensibly done given the multi-layered dynamics which affect the economy in these straightened times escapes me. That said, trading is all about second guessing the unknown. Holders of US tech stocks which were but a one-way bet until they weren’t, will know what I mean.

Economic releases are rarely uniform although it is clear that more recent ones are pretty clearly biased towards the onset of a recession in 2023. Whether it will be a quick bounce off the bottom or whether it will develop into a full-blown collapse is moot. The Turkish-Persian-American economist, Nouriel Roubini, who sprang to prominence as being one who in 2006 not only predicted the onset of the GFC – Global Financial Crisis – but also where it would be coming from is of the opinion that what lies ahead is not merely going to be a repeat of 1978 but more likely of 1929. Roubini’s argument, one which I have continued to support myself, is that the global economy has never before had to deal with such astronomical levels of debt and that the room for manoeuvre available to fiscal and financial authorities has never before been so limited. He sees the stagflationary juxtaposition as being as good as axiomatic.

Holding with the empirical wisdom that economists have successfully predicted seven out of the last two recessions, one cannot but hope that Roubini is ever so slightly crying wolf whereby not being able to see the wolf does not necessarily mean that it is not there. At the end of last week, US 10 year yields were at 4.23%. At the time of writing, they are at 4.023%. The 2 year note, the canary in the money markets’ coal mine, has fallen from 4.61% to 4.41%. So, both have come down by around 20 bps in three days and the inversion in the yield curve remains more or less the same. Bondologists would interpret that as the yield curve perfectly pricing in an impending recession but one which is pretty close to biting which should in turn put an early end to the Fed’s tightening cycle.

Sleepy Joe Biden is in a fix. The thought of mortgage rates coming down should put a spring in his step but the reason for them beginning to decline will not. And he is not alone in facing the approaching train crash where politics meets economics.

The new British Prime Minister, Rishi Sunak, also has a bucketload of issues to cope with, the first of which will be his being written up by the media for being of Indian extraction, for being only 42, for being very rich in his own right and even richer for being married to an Indian billionaire’s daughter and, last but not least, for applying to his personal finances British tax law as it is written.

On Tuesday, he faced The Rt Hon Sir Kier Starmer, the leader of His Majesty’s Loyal Opposition, in his first Prime Minister’s Question Time which is known in this country simply as “PMQ”. Sunak’s image is one of a very bright, no-nonsense kind of guy for whom ideology means relatively little. He is not of the loony right as were both Boris and Liz Truss and for that alone the parliamentary opposition will not forgive him. No more cheap shots over the cost of wallpaper or dodgy ways of sourcing income. Sunak doesn’t need the money. He looks to be a leader in the 19th century mould who is doing it because he thinks it is the right thing to do. He will be able to afford to pay for his own duck house. Please don’t get me wrong. Sunak did not become Prime Minister because he isn’t highly ambitious. The fact that he has in seven years risen from being a newbie MP in Westminster to becoming Chancellor of the Exchequer and now Prime Minister indicates that he is either highly talented or a fearful backstabber. My guess is that he is rather more of the former than the latter.

I did have to laugh when he stood in the leadership election which he, for reasons I shall never fully grasp, lost to Liz Truss. The broadcast media which for their own reasons deeply despise the Tories and anything to do with them kept banging on about how Sunak who was rich could never understand what it means to be poor. Nothing about the fact that he is the son of immigrant parents, was born in Southampton – I guess somebody has to be – and has proven that, if bright and ambitious, the sky’s the limit. It is the hated Tories who have put three women and now one first generation immigrant into Number 10 which is another fact for which they will also not be forgiven.

Sunak has put Suella Braverman, another first-generation immigrant, into the Home Office – the Ministry of the Interior in other lands – and has appointed a further one, Nadim Zahawi, who was born in Baghdad in Iraq before his parents moved to this country, to the role of Chancellor of the Duchy of Lancaster. It might be a bit of an arcane title which means little to those unacquainted with the ways and means of government but in reality, it is the Westminster equivalent of being the Prime Minister’s Chief of Staff and as such the second most powerful role in cabinet. None of this matches up to the “narrative” of male, pale and stale. Thank the Lord that there is Jeremy Hunt at the Treasury so that there is at least one big beast at whom this equally stale accusation can be directed.

But that still leaves the oppo’s jibe that Sunak will not be able to understand how hard it is to be poor. The complaints go on that three out of ten MPs are Oxbridge graduates. I don’t know about you but if Oxford and Cambridge are the best universities in the country and attract the best of breed, then in my book not enough of them can have gone there. I want to see the country run by the best, by the elite, and not by the most average. Throughout my career, I have never been happier that when I have been able to look up to my boss. Nobody wants to be led by someone who is no better than themselves or, heavens forbid, inferior.

It might be that Sunak doesn’t know what it means to be to be poor – and most probably neither do the other 90% of MPs who are university educated – but then what does, for example, Labour’s Deputy Leader Angela Rayner who left school at 16 know about running the businesses that create all the jobs and sit at the base of the national economic edifice? Reading one’s Marx and Lenin and even Bakunin is one thing – I have to some extent done all three – but it is another to be acquainted with Mosca, Pareto and Burnham. Vilfredo Pareto, creator of the “Pareto Principle” or “80/20 rule” which holds that 80% of outcomes are brought about by 20% of the causes, and Gaetano Mosca were early elite theorists. Mosca concluded that there are elites and counter-elites which replace one another at the top of the pile but to the general exclusion of the constituencies which they purport to represent.
James Burnham was an American philosopher and former Trotskyite who observed that if an equal distribution of power cannot work within what ought to be the perfect environment of a communist league, then it cannot work anywhere. In his seminal work “The Managerial Revolution” – I think I might have lost my own treasured copy – he observes how the owners of the means of production are no longer their managers and that a managerial class has emerged which rises to power by dint of education and leadership skills. Funny that, eh?

I am staggered by the speed at which the press is digging around to find anything they can sling at Sunak and by all accounts they are lining up to highlight his tax affairs. Sunak didn’t write the tax law and I can see no reason why he should be ashamed of using it to the best of his benefit. I guess they’d rather have someone in charge who is too naïve or too dumb to read the rules and then to apply them. One of the oldest observations in the book when it comes to understanding the difference between Britain and the USA is the one about the Rolls Royce. If an American sees a guy in one, he tries to work out how he can get one too. The Brit, on the other hand, tries to find a method by which he can take it away from him. There are days when I’m proud to be British and there are days when I’m not.

Back to the real world and to the conundrum which is energy. A couple of day ago, I had an exchange with a friend with respect to oil, a subject which certainly keeps us on our toes. It has always been an equation with two variables which are demand and supply, the two of which are not co-related. Getting both of them and in subsequence price formation right is a full-time job and one which few have ever mastered. It was, however, only yesterday and upon receipt notes from “Mr Tix” – Martin Tixier was once one of my juniors, but he has emerged as an unexpectedly brilliant market analyst – and again from another reader that I fully grasped that we are not dealing with two but with three variables, the third one of which is tanker capacity and availability. Western sanctions include a ban on discharging tankers transporting Russian oil if its price exceeds the US imposed price cap. On that basis alone, price action is not only driven by OPEC+ output but then by the ability to bring it to market. Transport, so I understand, is booked at least two months before loading so we have yet to experience what happens when the reduced output puts to sea. At US$ 87.50/pbb WTI is at the high end of its recent trading range.

Gas prices remain volatile with NYMEX natural gas priced at US$ 5.66/MMBtu. In August it peaked at US$ 9.68. The Dutch TTF Gas Future is traded by the megawatt so direct comparison are tough for the amateur but suffice to say that its price in August was around €355.00 and is now at € 99.00. Just an idle observation.

President Biden has less than two weeks until the mid-terms and he is grappling with keeping the pump price as low as he can. US oil exports are at a record level as it is making up for the loss of Russian supply to its Western allies. But that then tightens supply at home which in turn keeps domestic prices up. Americans might in general be supportive of Washington’s backing for Ukraine, but does that stretch to paying more to fuel the car? Don’t expect an unequivocal answer on November 8th. My guess is that on November 9th we will once again conclude that “The people have spoken but we don’t quite understand what they’re telling us”.

I was yesterday having a wide-ranging chat with Maggie Pagano, Reaction’s editor, and we came to the subject of the mayhem in the gilts market. Maggie is mildly frustrated with the cause of the rout, as she sees it, having been rather narrow-mindedly laid pretty much exclusively at the door of the unlamented Truss administration. I believe she is going to write a piece that shines the light from a different angle that highlights the role the Bank of England played in stuffing the Treasury, the Debt Management Office and a scad of pension funds which were tied into Liability Driven Investment strategies. I shall be reading it with great interest and suggest you might choose to do so too.

The author is a retired City trader specialising in fixed income who now works as a freelance strategy consultant. 

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