By Michael Every of Rabobank
"Correct Their False Path"
Yesterday’s market movements were clearly risk off. Key bond yields were lower; equities were lower; oil was lower; and the USD was higher, except against JPY. One can stoically say “stochastic”, but there was no obvious trigger for this shift in sentiment. It wasn’t as if higher bond yields pushed stocks down; it wasn’t as if higher energy prices pushed everything else down either.
Some of the financial commentary this morning is trying to explain that assets were out of line with reality: Never! I already pointed out a key indicator of “inflarted” asset valuations this week. It also says that stimulus can’t just go on forever. Really? That’s not the meme we have been sold for months, or the one central banks are still adamantly sticking to. In short, the simple message is that markets had to “correct their false path” *shrug*. Logically, one could argue that there are key risk-off drivers out there, however:
Germany is going into further lockdown until at least 18 April, warning of a whole “new pandemic”, and meaning a third of 2021 is a write-off. This underlines the degree to which the virus is still out there despite markets pricing for full global health for months;
Hong Kong has made clear it won’t be removing lockdown until 50% of the population are vaccinated (it’s now around 5%), and the UK --way ahead on vaccinations-- says foreign summer holidays probably aren’t going to happen;
New Zealand’s targeting of housing investment via taxes is a harbinger that populism is not actually going to be popular with all markets…and housing may be an easy target;
US Treasury Secretary Yellen was yesterday also stressing the need for tax hikes;
Massive market volatility in Turkey, despite its endogenous origins, could still spill over into the broader EM complex if it escalates. It again underlines politics can rain on the market parade; and
The Suez Canal is blocked by a giant Chinese vessel, and there doesn’t seem to be a plumber.
Naturally, markets or algos will soon remember that vaccines in pill form are being floated; HK is just HK and NZ is only NZ; Cornwall and Devon are lovely; taxes are for the little people; Turkey is Turkey; and there is always a cheap plumber in a globalised economy. Yet where market correction and reality overlap is that “correct their false path” is also the message China just delivered to the German ambassador. Allow me to unpack the implications of this.
China’s aggressive counter-sanctions imposed on the EU over the latter’s largely-symbolic sanctions China were not imposed on the UK, US, or Canada. This was either oversight or deliberate. If oversight, expect further Chinese actions and a souring of global relations – and a drift to a deterioration in trade and capital flows markets despise. If deliberate, China is picking out the EU as a weak link, and focusing on Germany in the belief its corporates are the best leverage to prompt Europe to ‘see the error of its ways’ (i.e., standing at the back and saying ‘Yeah’ while the US and Australia shout, and Australia and Canada take the punches). In which case, China does not understand that even in the EU, politics can trump economics. Spines are now stiffened, and the European parliament has made clear it will not pass the China investment deal while its own members (and their families) are under sanction. Yet Beijing is extremely unlikely to blink: and so we again risk souring global relations snowballing into a deterioration in trade and capital flows.
History, like markets until the last few weeks, seems to be happening on fast forward: and I reiterate this matters far more than markets grasp.
Commentary correctly points out the S&P just had its best 12-months since 1936, where it rose 27.9%; they also point out what happened in 1937, where it collapsed 38.6%. Is this episode going to be repeated? It seems extremely unlikely central banks are going to repeat that particular error --premature policy tightening-- to precipitate a similar crash. So all is well then? Not really.
While central banks can stop a 1937 or a 1929, they are powerless to stop a 1789 or a 1939 or a Cold War: and 1937 being a year closer to 1939 is arguably the more worrying analogy as geopolitical tensions escalate. We just saw another US defence official warning about the risk of hot war over Taiwan, for example. Moreover, tech giant Intel is about to boost US semiconductor production via a USD20bn pair of new Arizona plants. Yes, we have a major supply squeeze in the industry all of a sudden, but plants take time to come on line: and what does the firm now see that the economics/market forces of where plants are located didn’t seem to make clear to it until recently? Back in July 2020 Intel was considering outsourcing production to other firms and countries (such as Taiwan).
I am not saying the market is suddenly pricing for the geopolitical backdrop: it clearly isn’t – even if it will react to individual events and individual firms reacting to it. Indeed, the retort I often get is that markets in general don’t even know *how* to price for this kind of thing at all, so don’t even try. To which, in a Taleb-ian sense, ask yourself: “How often would you and yours eat in a family restaurant with a reputation for being bombed?” – even if the steak frites are to die for. Of course, as we already see, not eating out means lower interest rates anyway, so perhaps there really isn’t a problem!
In short, one can worry about central banks tightening, and that would certainly see markets correct their false path;
One can worry about central banks not tightening, and that would see markets on an even falser path;
Yet one should worry most about the geopolitics of “correct their false path” - and that central banks are not able to do a thing about the path of history, wherever it is leading us.