Submitted by Michael Every of Rabobank
Mr Market continues to tell us that Brexit is in the bag and that a US-China trade deal is in the bag too. Not only that, but a global slowdown isn’t happening after all. What else is one to think as equities continue to surge, as bond yields continue to surge (2% in US10s is now being openly discussed), and as risk is very much on?
Don’t get me wrong. I openly extoll the value of markets and their price-discovery function. Without them we are really in trouble in many respects. However, as I also underline regularly, markets are not always right. They can be disastrously wrong, in fact. Exhibit A: How much was WeWork worth a few months ago, and how much today? The value of markets is that they can and do change their minds rather than dictating to us. Don’t rule out exactly that kind of mind-changing again sooner than you think.
First, Brexit. As we trundle to the Bre-lection that apparently precedes it, every political pundit notes this is impossible to call. One thing they do say, however, is that a Labour victory cannot be ruled out. Without wishing to express a preference on the UK political front, it isn’t every day the leader of the current opposition is criticized as “akin to Stalin” by the caretaker PM. Simple question: how will British, and global, markets look in five weeks if we get “Stalin” running the UK? Is Brexit really going to be the one thing they no longer worry about?
Second, the US-China trade deal. Despite China insisting on the US removing at least some tariffs, if not all, as the terms for a “phase one” deal, an argument backed by several local sources, including one close to Liu He, the market thinks that this is ‘in the bag’. Nobody thinks Trump is on board yet – but apparently that no longer matters! The latest sweetener, according to Bloomberg, is that China is finally getting serious about cracking down on fentanyl production, which has been a bone of contention between the two: is that really going to be enough to produce an extended trade peace? Apparently, yes, says Mr Market. Yet perhaps he is on fentanyl given agri markets which should be soaring on a US-China deal are not yet doing so? Let’s see what the Shanghai import expo has for us today on that front.
Third, the global slowdown. US services data were mixed yesterday. The Markit PMI was at a level where we should be buying bonds hand over fist; the ISM survey more upbeat, as was payrolls, of course. Regardless, was “Trade War!” the only thing weighing down the global economy of late, and that now this is “sorted”, sunny uplands await us?!
The global slowdown is multifaceted, but structural – and a large part lies in China and its distorted economic structure, where more and more inputs produce less and less profitable output. Even local governments, happily spending 2020 bond issuance in advance, are now complaining that they have nothing viable left to build or invest in. Steel output will be up around 7% this year, on pace to double again in a decade, even as global oversupply surges and the Chinese steel PMI slumps. Indeed, most of the Chinese economy is in the doldrums apart from an overheated property sector and, yes, steel. Of course, removing the serious FX- and supply-chain-shifting risks associated with the end of the trade war helps China: US trade data yesterday showed a large m/m and y/y fall in Chinese exports to the US in September as new tariffs kicked in, and a larger drop in US sales to China. But regardless of “phase one”, China’s structural problems aren’t going to go away.
Another large part of the global slowdown is the global political-economy structure producing a distorted allocation of capital, something we have also pointed out repeatedly. In short, too much money in too few hands, and nothing for them to spend or invest it on usefully apart from asset bubbles. Hence flat real wage growth, declining productivity, soggy consumer spending--or rising consumer debt--and output based around property or equity prices rather than real businesses. (Which we have just noted is also true even in China.)
True, we are *finally* seeing signs of government doing what it should have logically done years ago, and stepping in to fill the capital-recycling/investment gap. In the UK, for example, all parties are pledged to vastly increase public spending; ECB President Lagarde is urging Europe to do the same; BOJ Governor Kuroda was this week suggesting that more fiscal-monetary fusion was needed to get things moving; and the US fiscal deficit is already vast.
However, problem still loom. The UK has a rotten track record of actually spending that public money usefully. Look at the GBP7.5bn bill for the HS2 train to date, for example: where exactly did that go considering NOTHING has been built? Europe is steadfast in refusing to spend the money the ECB is urging it to. Japan has just raised GST to 10%, despite what happened last time consumer taxes went up. And the US fiscal deficit has been widened via a tax cut that went straight to the rich rather than into the actual economy (to cheers from the new IMF boss).
So here is the question for you, Mr Market. Let’s assume Brexit is done and the UK election ends up with something that isn’t Stalinist, and Trump can sell China turning off the fentanyl taps as a way to reverse this trade war:
- Will central banks keep cutting in that environment given “all is well”? Probably not. Cue a tantrum from Mr Market.
- Will governments press ahead at more than a snail’s pace with useful investment given less urgency to act? Probably not. Cue a tantrum from Mr Market.
- Will debt-laden economies be able to cope with higher yields if we do see mass stimulus? Probably not. Cue a tantrum from Mr Market.
- Are we prepared for the massive multi-layered side-effects that will flow from a slide towards mass use of MMT ahead? Certainly not. Cue a tantrum from Mr Market.
So what will we blame our structural global problems on as they continue to play out? We need an easy-to-understand bogeyman, and Trade War works nicely.
‘Fortunately’ there is always the fall-back of “Populism”, as a growing list of countries see street riots – but that comes worryingly close to criticism of the global system. It also just doesn’t play as well with the business world and public: I find it hard to see a central bank rushing to cut rates three or four times “because of the risks of populism”.