By Michael Every of Rabobank
"... And Then?"
Thursday was another down day in most markets, with staggering moves in some. US stocks closed down (-0.9% S&P) and had their worst H1 since 1970. How many Wall Street analysts had that pencilled in?
Bonds rallied. US 10s breached the key 3% level, which had been establishing itself as a floor vs. a 3.50% ceiling, but were back above it at time of writing. European bonds have seen a staggering two-day move, with German 5s down 35bp in just two days, apparently only the third time that has happened in 20 years, and 10s down 29bps. That was despite Reuters suggesting that the ECB would buy Italian, Greek, Portuguese, and Spanish bonds with the proceeds from German, French, and Dutch bonds. Yet overall bonds still had an H1 for the ages too – in a bad sense.
Commodities got smacked again and are all well down from their 2022 peaks. Base metals have given up all their Ukraine war gains. Yet oil as the key benchmark is still up 48% year-to-date. Javier Blas from Bloomberg also picks up the Banque de France flagging concerns about global commodity trading, which it calls an "oligopolistic market", with "potentially systemic importance and moral hazard", and where "more extensive work still needs to be done on the regulation." This is red flag that has been waved by the Fed before.
Bitcoin crumbled further below $19,000. The US dollar once again was up sharply, then down again, with the DXY at 104.7, having been at 105.5. If we see another spike that is held even as everything else starts to collapse,… well, fasten your seatbelts. Fed swap lines will be needed.
In short, if you bought stocks in H1, you lost; if bonds, you lost; if commodities, you were doing great until recently; if crypto you lost; if the US dollar, you were fine.
Some of the extreme moves we have seen recently were likely exacerbated by end-month and end-quarter flows/repositioning. So, now on to Q3 and H2.
We kick off with the Atlanta Fed Q2 GDP tracker being revised down to -1.0%, meaning the US *is* already in recession even before we have to worry about one ahead. At least that clears the picture a little.
Except that supply chain chaos may be easing at sea in some places, but worsening in others. As Freight Waves puts it, “The jaws of the supply chain vise are squeezing trade so tight that the headache it is creating will be a whopper for logistics managers this peak season. Port congestion is growing again as a result of labour and equipment inefficiencies.” More, properly-focused workers are needed urgently, is their conclusion. Indeed, alongside airport chaos, American Airline pilots are getting a 17% pay rise to try to keep things running. Yes, 17%, not 1.7%.
In short, some pipeline deflation is evident – but not in energy: and pockets of structural inflation remain that cannot be resolved by the stroke of any central bank pen.
Listening to recent commentary, the market appears madly focused on the idea that for all of the calamites unfolding around us there is one simple solution - the Fed cuts rates, and soon. Making that call is important, and particularly because it means ignoring what the Fed, every central bank, and the BIS, just said loudly and clearly – that rates are going up a lot anyway. However, let’s presume the Fed and every central bank is wrong (which is a healthy place to start) and the market is right (which isn’t), and a Fed pivot is imminent (which may be true).
My key question is: “…and then?”
Most of the market doesn’t seem to have an answer in terms of the big picture. It doesn’t even want to try to think of one. Fed cuts will apparently make all our issues go away. Yes, a logical near-term response is “go long stocks; long bonds; long commodities; short the US dollar; long crypto; and long risk”.
However, my question is still: “…and then?”
What about Inequality? Energy prices? The food crisis? Regulation of commodity markets? Geopolitics? National security? The war? The climate? How does this all join up, and where are we going even if we do get lower rates?
I cannot tell you how few market commentators are willing to even begin to answer those questions holistically:
- because it’s hard; and
- because “go long stocks; long bonds; long commodities; short the US dollar; long crypto; and long risk”, makes lots of people lots of money.
So, they will keep peddling their threadbare wares, and I will keep saying “…and then?” until I get some answers like the annoying voice at the Chinese restaurant in that avantgarde arthouse US film ‘Dude, Where’s My Car?’ And ‘wonton soup’, while nice, is not going to be one of them.
To make my point, yesterday saw another huge US Supreme Court ruling: this time to roll back the “administrative state” - as Justice Thomas had flagged in an interview. Specifically, it ruled the Environmental Protection Agency has limits to its regulation of carbon emissions. As with Roe vs. Wade, elected officials now have to make decisions on crucial matters, this time federal not state.
Which regulator will be next, and which key legislation will then be added to the pile for a dysfunctional Congress that has a narrow Democrat majority now, but which is likely to see a larger Republican (and MAGA) one after the November mid-term elections?
To repeat another point I had made on Monday, if you extend the logic of the ruling, the Fed may get nervous. I’m not sure exactly what case somebody might be able to bring against the 1913 Federal Reserve Act --perhaps being egregiously harmed by QE?-- but if they can, we might find out if this Court thinks the Fed also has de facto executive power, enforcement power, and adjudication power outside of the constitution.
The ECB dealt with similar issues in their German constitutional court case in recent years and emerged even more powerful – but then Europe generally likes centralized regulation a whole lot more than US conservatives do. Yet one wonders how the ECB will fare politically if it starts selling core bonds to buy peripherals, and once we eventually find out how its much-vaunted but even more controversial Anti-Fragmentation Tool (AFT) actually works --or doesn’t-- in practice.
Who knows? But more volatility surely. Does the Fed get to keep control when other elements of the administrative state fade away? Or does the Fed gain greater power via regulation of commodity markets and expanded dollar swap lines (for friends only),… and then do central governments gain greater powers over central banks to ensure national security needs are met?
We have to look bigger picture. Turkey is to get new US F-16s, and so Greece is to get new US F-35s (partly paid for by the ECB via German, French, and Dutch bonds).
Not too far away, and despite the utopian prognostications of the EU’s foreign policy bumblebee Borrell, the word on the street is the Iranians are playing hard ball in the latest indirect US-Iran talks because a powerful clique in Tehran is not sure if they want to bother with the pretense of the nuclear deal or not. People are really talking about the “last chance” for any agreement.
New Zealand agreed a trade deal with the EU. Yet PM Ardern’s warning at the recent NATO summit --also attended by Australia, Japan, and South Korea-- that China is becoming more assertive, has drawn a sharp rebuke, as did the summit’s focus on China as well as Russia. Beijing has noted Ardern’s “misguided,” “wrong,”, and “regrettable” accusations.
In the US, Senate Minority Leader McConnell has now threatened to withhold support on the until-now bipartisan US COMPETES Act aimed at helping to onshore semiconductor production, if the bill also includes items not related to the issue at hand. Relatedly, just published a look at the potential for ‘friend-shoring’ of supply chains from China to others (‘Friends Reunited’). The simple conclusion is that were this to happen on even the limited scale we project relative to China’s total labour force, it could transform global trading patterns; moreover, China’s trade surplus would swing to a deficit, leading to lower GDP growth and an inability to use fiscal and monetary policy to compensate without a balance of payments and FX crisis.
Obviously, China will do all that it can to retain its trade ‘MySpace’ as a result.
“…So, we think the Fed will cut rates…”
Happy Friday, July, Q3, and H2.