By Michael Every of Rabobank
“Isn't it rich? Are we a pair?
Me here at last on the ground, You in mid-air...
Where are the clowns?”
Rarely does one make a market call chanting terrace-like, “You don’t know what you’re doing!” to those who thought the Fed ‘hit the right note’ or ‘threaded the needle’ Wednesday - and so bought stocks AND bonds AND commodities AND sold the US dollar - and then see it completely vindicated within 24 hours. I should buy a lottery ticket. Or an NFT, which is the same thing but doesn’t fund good causes.
Yesterday was a market bloodbath. The S&P was -3% and the NASDAQ -5%, Treasury yields surged and bear-steepened the curve (2s +8bp, 10s +11bp to 3.04%), the dollar hit a 20-year high on DXY, with the next technical level all the way up at 120(!); gold and crypto slumped; and key commodities went up. Note the one variable that keeps doing just one thing.
And if you think the US was gloomy and the Fed feeling the pressure, allow me to introduce the damp, overcast UK, where the Bank of England raised rates 25bps but was split three ways between don’t hike, do 25, and do 50. The Old Lady of Threadneedle Street did no needle-threading, but rather said the UK faces recession and inflation of 10%, and overall misery for years. GBP was smacked like a Tory Council (as local election results trickle in), down from 1.2640 to 1.2340. Perhaps the Bank could have lied and said they were confident the economy was fine and would find a soft landing, like the Fed. Stefan Koopman, speaking of the suddenly bleak UK outlook, underlines he has “sounded this particular alarm bell for months on end.” Indeed, he has been singing “You don’t know what you’re doing!” on the terraces too. He also argues (here) that we have another two 25bps hikes to go and then there will be a pause to assess what has been wrought. Unless, perhaps, GBP keeps doing what it is doing, in which case that view might have to be reassessed(?)
“Isn't it bliss? Don't you approve?
One who keeps tearing around, One who can't move...”
Where are the clowns? Send in the clowns.”
And through all this the BOJ is still wedded to 0.25% 10-year JGB yields paid for with freshly-minted money despite Tokyo CPI at 2.5% y/y. JPY at 130 will soon be JPY at 140 or 150, one might think.
“Just when I'd stopped opening doors,
Finally knowing the one that I wanted was yours.
Making my entrance again with my usual flair
Sure of my lines... No one is there.”
What is the correct response to this? Higher rates? One can argue no. Lower rates. One can also argue no. More state spending? One can argue no. Less state spending? One can also argue no.
Of all the combinations above, the best is arguably higher rates and fiscal stimulus DIRECTED AT INCREASING SUPPLY, NOT DEMAND. If that means friend-shoring, so it’s friend-shore; if it means onshoring, so onshore; a ‘Network of Liberty’, so network; automation, so automate. Just don’t think the supply-side will work itself out while you deal with demand.
Perhaps it’s easier to ignore all this and put a lick of greasepaint on the same old, same old, as markets tried on Wednesday. Similarly, France’s President Macron has renamed his political movement for the second time ahead of next month’s parliamentary elections: the first was from En Marche to La République En Marche, and now that becomes Renaissance. One thing I will say in favor of the new name is that period of European history was all about the supply side, Great Power politics, and mercantilism.
Likewise, in China, the Politburo has reiterated that hard lockdowns are the way to go, and hard questions about them aren’t – even playing the left-wing anthem the Internationale is now out. In which case supply chains won’t be seeing most goods go anywhere globally,… until the actual supply chains themselves go global in response. Within China, Bloomberg reports that property developers trying to sell assets are finding almost no buyers – what a surprise!
“Don't you love farce? My fault, I fear.
I thought that you'd want what I want... Sorry, my dear!
And where are the clowns? Send in the clowns
Don't bother, they're here.”
US officials keep boasting about they are helping kill Russian generals and sink Russian ships. This is dangerously clownish. Yes, everyone knows they are. No, you don’t rub Russia’s face in it in public, because it risks a backlash that will escalate tensions even more.
Yesterday also saw the US announce that it would begin to buy back 60m barrels of oil to refill its Strategic Petroleum Reserve – at higher prices than it sold from it at. Expect oil prices to go even higher. Expect diesel prices to go higher than that. Expect a crushing impact on logistics firms – or immediate pass-throughs to all goods and services to prevent bankruptcy. Expect Russia to have even more money to spend on the war.
Again, what is the best policy response? Probably to hike rates and the dollar until commodities break, and to pledge federal support for massive new energy supply. What is the worst policy response? What every government will --understandably-- try to do, which is to cushion the blow fiscally. If that is going to happen then at least help the poorest first and most. Don’t, for example, rush to cancel student loan debt for the 1/3 of Americans who went to college in the hope of earning most, which would boost demand – for some.
Elsewhere, the Supreme Court is hidden behind fences, like the White House recently; the FDA has strictly limited the use of the Johnson & Johnson Covid vaccine over links to heart problems; the New York Times is arguing apartheid South Africa had too much free speech, and implies Elon Musk might turn the US into apartheid South Africa too if he lets Twitter give free reign to people (to voice concerns over Covid vaccines’ links to heart problems ahead of the FDA?); and the FTC is floating an anti-trust case against Twitter now it has new ownership, even though no M&A was involved. The last thing the polarized US needs is a spike in energy and food prices and a collapse in 401Ks. Yet it will arguably have to have one of the two, and it might get both.
“Isn't it rich? Isn't it queer?
Losing my timing this late in my career.
And where are the clowns? There ought to be clowns...
Well, maybe next year.”
No need to wait that long. We just saw the RBA’s Statement on Monetary Policy. It noted, “The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead.” So, whatever it takes, mates?
On housing, they say construction has been supported by specific policy measures, which the next government will continue in one form or another --wrongly boosting demand not supply-- and the low level of interest rates. Demand for mortgages “has been robust… but broader housing market conditions vary across the country. In Sydney and Melbourne, established housing prices are declining and rental inflation has been subdued. Elsewhere, housing markets are tight, with prices and rents both increasing strongly and the available stock for sale or rent at low levels.” There does not appear to be much dot-joining from the pledge for higher rates to what that implies for the over-leveraged housing market. As such, the SoMP was written by someone wearing ridiculously large red shoes.
Today will probably also see a deeply-bruised market attempt to rally – because it hasn’t learned any lessons yet, and that’s what it does by default.
Helping on its way may be US payrolls, as if we didn’t have enough volatility already. The consensus is 380K. Let’s imagine we get a very strong print – does that mean a further market sell-off? Probably, yes. After all, the Fed would believe they are right to keep ploughing ahead with 50bps hikes – and commodities are still going up. But what if we get a very weak print? One would presume then we see markets try and rally, because the Fed will have to hold off. At which point commodities will go up even more.
Commodities are the supply-side joke flower that squirts water in the demand-focused market’s eye every time they lean in to smell it.
Indeed, anyone humming ‘Send in the Clowns’ today needs to be doing it ironically, like The Krusty Comeback Special – with schmaltz by the bowlful. I am just not sure markets are making a special comeback.