The markets are trapped and don’t know which way to go

The mood out there is not great. My friend and commodity guru Piers Harden of Esken Renewables describes it as: “The markets feel like when we are waiting for a parcel delivery, firstly when will it arrive and then what will be in it the parcel.” Although he was in fact referring more directly to the US debt ceiling situation, I think the analogy can be applied far more widely. I myself would refer to the closing scene in the wonderful Richard Attenborough film version of Cornelius Ryan’s equally wonderful book “A Bridge Too Far” that tracks the military fiasco that was Operation Market Garden, the attempt by the Allies in 1944 to jump ahead by seizing the Rhine bridge in Arnhem. In it and reflecting on the failure of assault, Generals Urquhart and Browning list the reasons for the failure. It was the weather, it was the road, it was… until Browning owns up that it was simply a bridge too far.

Markets across pretty much all asset classes are at sea. Is it Ukraine? Is it China? Is it the debt ceiling? Or is it the central banks? Were I in the Boy Browning role in this discussion, I’d have to conclude that it’s recession too few. What do I mean? I’ve been writing these musings for a very long time but also a lot less long that I’ve been observing economic cycles. I was after all already 19 at the time of the 1973 oil shock and therefore have living experience of the deep recession that followed. It took a long time for the whole scenario to play out, for a new economic order to establish itself, a large part of which was the de-industrialization of vast swathes of the West. British manufacturing industry was particularly hard hit but it was not alone as the American Rust Belt went into terminal decline, as did France’s Lorraine and Nord-Pas de Calais, as well as the German Saarland. In this country it took the abortive 12-month miners’ strike from March 1984 to March 1985 to bring the reconfiguration to an end and for it to become clear that what once was is no more, and that it isn’t coming back.

The late Baroness Thatcher was to many the villain of the piece to the extent that when she died in 2013 my fearsomely left-wing sub-editor at the International Financing Review tweeted “Ding-dong the witch is dead…” Maggie Thatcher was, and remains to many who were not even alive when she was Prime Minister, the devil incarnate. One of the great mysteries of mountaineering history is what happened on the Matterhorn in 1865. The Englishman Edward Whymper put together a team in order to conquer it. This they achieved although on the descent someone on the lower end of the rope slipped, fell and dragged the team downwards. Whymper, higher up, is said to have cut the rope. Did he do so simply to save himself and in doing so did he miss the opportunity to possibly save those below him? Or would he and all the rest also have been dragged down to their deaths if he had not done so? Did Maggie simply cut the rope at the critical moment? Would there have been a future for British metal bashers, car makers and coal miners? To this day the argument rages between the Left and the Right although even without Maggie America’s Bethlehem Steel, France’s MMRA and Luxemburg’s Arbed ran out of road.

The rise of China has excited us as for three or more decades it offered a thriving market for us to export know-how whilst providing us with cheap and plentiful consumer goods and by extension imported disinflation. Enter, stage left, Sir Mervin King’s legendary NICE economy – non-inflationary constant expansion. Oh for the halcyon days of the first half decade of the 21st century. As China continued to develop and as both its need and its ability to produce high quality products at knock-down prices began to wane, the West found to its horror that it had mistaken the exception for the norm. The 2007/2008 GFC was something akin to it hitting its head when it suddenly woke and leapt up. A reality check was not of the order and the central banks obliged by, if you are to borrow from the former Fed chairman William McChesney Martin, refilling the punchbowl. ZIRP and NIRP – zero and negative interest rate policies – were and marginally still are the life support systems for a socio-economic model which has again run out of steam.

China has not only caught up but in many areas has already overtaken us in terms of being able to conduct top-end manufacturing. At the same time its growth trajectory is inevitably flattening so that Chinese demand for Western equipment is being squeezed by both falling demand and an increasing level of domestic capacity. The great fight over Huawei is symptomatic. Yes, of course it has deep-down embedded Ninja software which is hard to identify but anybody who believes that our American friends are not just as good and just as active in doing the same must be smoking something for which the likes of us gets a criminal record. The epic €1.3 billion fine slapped by the EU on Meta – that’s Facebook to you and me – is a pretty straightforward case of US tech demonstrating no more respect for the integrity of its users’ data than that for which Huawei is being demonised.

We are in the midst of a socio-economic revolution, the direct and rather painful effects of which have been held back by nearly two and a half decades of easy money. It should not be forgotten that the GFC, although of itself a laying bare of the risks of credit-fuelled rather than value-added created growth, was triggered by the monetary authorities’ attempt to begin to normalise interest rates after them having been slashed in order to counter the most probably incorrectly perceived economic risks of “9/11”. The Covid-19 pandemic postponed the re-tightening monetary policy and reinforced the erroneous belief that central banks are here to prevent the on-set of recessions. That they are not. They are here to help manage them, to soften the blows and to facilitate the transition from recession to recovery. But they are not here to prevent them.

Sadly, however, that is what they are widely believed to have written into their remit and former ECB President Mario Draghi did his peers and his and their successors no good at all with his famous “…whatever it takes…” speech. Draghi politicised monetary policy to the extent that when Christine Lagarde was appointed as his successor, I commented that she was not there as a central baker but as de facto Minister for the Single Currency. I have to take my hat off to her for not playing to that tune and for demonstrating an ability to discreetly show the Eurocracy in Brussels a middle finger salute.

The rise in inflation and its persistence has brought forth many comparisons with 1973 and observers have been looking to monetary policy at the time for guidance as to what might lie ahead. Jay Powell is no Paul Volker. Andrew Bailey is most certainly no Robert Leigh-Pemberton although in my book Christine Lagarde does in profile come close to Karl-Otto Poehl. And as far as the SNB’s Thomas Jordan is concerned, and with all due respect, it’s hard to even contemplate mentioning his name in the same sentence as that of Fritz Leutwiler. More or less by the end of Britain’s miners’ strike in 1985, the pre-1973 economy was dead and buried. How we measure when our current economic model will have begun to transition to whatever it is in the process of transitioning to will be for future economic historians to assess. The effect of the long easy money regime will make it hard to pin the date to either its beginning or its end. Does the end of the patient’s life begin when they go on life support which keeps them nominally ticking over or when it is finally switched off?

This is not the place or time to bemoan its prevalence but wokeness is symptomatic of an obsession with process over outcome. If we want to and need to compete with China and the rest of South East Asia, then we must acknowledge that those are countries in which the objective of one and all is to make as much money as possible. If it means going without material goodies or democratic rights now in order to advance investment, education and training for the future, so be it. A highly skilled and highly motivated workforce is worth its weight in gold. The arguments here over a legal right to work from home – I’m debating its merits and demerits with both my cleaning lady and my gardener – must have them laughing.

It appears that markets are trapped by not knowing which way to jump. I occasionally quote a former boss of mine who coined the phrase “If you don’t know where you’re going, you don’t know when you’re lost”. In my memory it was the first thing he ever said to me and, although we worked together for a year and a half, also the only intelligent one.

Watching the White House and Capitol Hill at war over the debt ceiling looks so like two starving dogs fighting to the death over a rubber bone. Does it really matter whether Treasury Secretary Janet Yellen is correct when she pins dates on when the last few cents will depart the petty cash box? Anybody who has lived through similar fights over the debt ceiling will know that there are all manner of means for the Treasury not to have to default on its bills, notes, bonds and other liabilities. We have all seen public servants being sent home along with appeals to the banks not to jump the gun by calling in their loans and mortgages. Biden and McCarthy both know that and only the young and inexperienced will believe a word of what they offer up as soundbites. What they sincerely declare to be their immovable bottom line and what it really is are surely not the same. Nobody goes into a negotiation telling all and sundry what they might in the end be prepared to accept. If they do, they have no right to be in either business or politics.

The media are obsessing about the rise in the yield of the US 2-year note to 4.33 per cent. In early March and long before the debt ceiling and the risk of default were front and centre of market interest, it was over 5 per cent. If markets were really, really scared, it’d now be several percentage point higher. One-year as well as 5-year credit default swaps on sovereign US debt also tell a story. They are now at 145 bps and 58 bps, respectively. I remember trading the 10 year CDS in size at 7bps but that was in 2007 just as the GFC was developing. Not the point; earlier this month the two were at 175 bps and 75 bps. So the market now ascribes a lower risk of default than it did a couple of weeks ago. Contangos are uncommon in credit pricing and have me wondering.

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