Submitted by Michael Every of Rabobank
Markets continue to trade as if we are all going to have a Hollywood ending where the good guys win, the bad guys lose, and everyone hugs and learns something. As a bellwether, AUD is up around 3.6% in four days. That is from a currency facing the worst economic downturn since the 1930s, the first recession since 1991 (as GDP was -0.3% q/q in Q1), a destroyed tourism sector, a housing sector which cannot logically hold up much longer, the threat of a breakdown in trade relations with key partner China, the linked recognition that its location is now geostrategically vulnerable rather than safe, and as the RBA pegs bond yields out to three years with the overnight cash rate on hold at 0.25% until full employment returns (so basically forever). Yes, there isn’t any mass rioting - but don’t think that there is no risk of it in the future if the asset-rich/income-poor socio-economic template of the past four decades is returned to as Covid-19 fades away.
In Asia the risk on rally continued, helped by the Chinese Caixin PMI coming in at 55 vs. 47.3 expected and despite China hassling a Japanese fishing boat in the Senkaku islands, adding another country to the list that it is clashing with and raising geopolitical tensions further. Likewise, the UK is lobbying the 5-eyes Anglo group to allow millions of Hong Kongers to leave for Britain (who will take 2.9m), the US, Canada, Australia and New Zealand: what does that suggest about the outlook? Worse, Russia’s President Putin has changed his national defence strategy to allow the use of nuclear weapons in response to conventional attacks that “impact on critically important government or military facilities”. That is both a warning to the US and a dangerous step away from a global no-first-use nuclear policy.
But hey! Let’s sit and look at paper profits on a Bloomberg screen as a delicious meal is about to be delivered by a gig worker risking Covid-19 and street robbery and who earns less than the minimum wage! Everything everywhere is being resolved Hollywood style, right?
Meanwhile, back in the home of the real Hollywood, nationwide street protests show few signs of abating – and markets keep going up and risk remains on. There are two equally-depressing conclusions here: 1) We no longer have actual markets due to central-bank elevation of moral hazard to the foundational pillar of financial capitalism; 2) We still have markets, but they find the idea of the US military operating on the streets to quell popular unrest to be reassuring – just as it would be in a banana republic where the asset holders are traditionally happy to do ‘whatever it takes’ to keep the peasants in line (incidentally, this may not be too far off; see "It's Official: The United States Is Now A Banana Republic".
On the latter point, potentially what we are seeing in the US is not just a breakdown of law and order. It could be a sign that an entire segment of the population is no longer prepared to “take it” - and if you follow the politics of those protesting, that “it” means the neoliberal asset-rich-income-poor economic system rather than just the disgusting racial injustice so recently on public display. With sympathy protests already taking place across Europe, which likes to think it is far removed from the US, but has a significant demographic who feel otherwise, this could prove to be a long, hot summer. Indeed, in the US the Washington Post today quotes CIA veterans “[expressing] dismay at the similarity between events at home and the signs of decline or democratic regression they were trained to detect in other nations.” Turchin has something to say about that, as does Piketty: recall his conclusion was inequality is only resolved by revolution and/or war.
Meanwhile, as ‘The Hill’ TV channel said yesterday, many giant US firms that have benefitted from or helped perpetuate this system are now trying to present themselves as in favour of the protestors in the hope of diverting the conversation away from the economic argument that underpins the unrest. When and how do central banks join in? Moreover, how do they get out of the trap they have set for themselves? You can tell we are in a crazy system when you project it forward and see that more liquidity means more unrest of one kind, and less liquidity means more unrest of another.
Of course, there is still the hope for a Hollywood ending if the US can deal with its underlying socio-economic problems: one should not rule that out, hard as it may sound, because that is what democracies are able to do – or are supposed to be able to do. Indeed, there are indications that there is a real US unwillingness to use the military to suppress these protests: even former President George W Bush, who used the military against Iraq in 2003 based on false evidence about WMD (whose father had done so in LA in 1992 to quell riots), has tweeted his opposition. So is the alternative a dialogue to address grievances? If so, expect major economic policy changes - which will necessarily mean ‘Mr Market’ gets downgraded from Hollywood mogul to the guy selling popcorn. How will he like that?
But hey, let’s get back to risk on trades by focusing on actual Hollywood endings. Below are the top five US box-office hits of 2020 (before Covid spoiled things) with added notes on how all of them are still positive for risk and for markets. (Because everything else around us is, right?)
Bad Boys for Life: Miami detectives must face off against a mother-and-son pair of drug lords who wreak vengeful havoc on their city. (Havoc is clearly risk on.)
1917: As a regiment assembles to wage war deep in enemy territory, two soldiers are assigned to race against time and deliver a message that will stop 1,600 men from walking straight into a deadly trap. (Deadly traps and the army are clearly risk on.)
Sonic the Hedgehog: After discovering a small, blue, fast hedgehog, a small-town police officer must help him defeat an evil genius who wants to do experiments on him. (Geniuses are risk on.)
Jumanji: The Next Level. The players will have to brave parts unknown from arid deserts to snowy mountains, to escape the world's most dangerous game. (Dangerous games are risk on.)
Star Wars: Episode IX - The Rise of Skywalker: The surviving members of the resistance face the First Order once again, and the legendary conflict between the Jedi and the Sith reaches its peak bringing the Skywalker saga to its end. (The resistance wins despite insurmountable odds. That should be risk off for markets, but let’s throw in lens flare and rapidly move on, JJ Abrams style.)