Who's All In?

Submitted by Michael Every of Rabobank

Who's All In?

It is undoubtedly a sign of the times that the Wall Street Journal’s former Fed whisperer Greg Ip has just written an article titled “The Debt is Soaring; Debt Risks are Not” that argues despite soaring US debt issuance the collapse in Treasury yields means debt-servicing costs are well under control; and that if inflation ever goes back up again then things look very, very different; however, it then asks, might a re-elected President Trump appoint a new Fed Chair prepared to keep rates low and maintain yield curve control regardless of inflation? That’s a logical hypothesis we put forward several years ago when the Fed as was still pretending to normalize policy as a political-economy market endpoint that, while awful, is arguably still better than, or at least preferable to, trying to raise taxes in this economy, or to slash state spending even further. Yes, one could always tax the rich, but we are talking about realistic outcomes here.

President Trump has helpfully decided to step back from daily virus press briefings after the whole disinfectant/sarcasm hoo-ha, and will now be focusing on how many more trillions of USD his next stimulus package will cost. Meanwhile, his likely presidential campaign opponent Joe Biden has criticized the White House bailout as being biased towards “greedy as hell” big business and banks. He has also argued that the next relief package needs to be a “hell of a lot bigger than USD2 trillion.” Then again, we have also just been told that his economic advisor is none other than Larry Summers…you do the math.

Regardless of which route the US ultimately goes, the BOJ today went all in and announced unlimited bond buying. Of course, they already hold a huge share of the huge stock of JGBs; but with PM Abe approving a fiscal stimulus package of up to 20% of GDP, there will soon be lots more to buy. Note the BOJ already has yield curve control at the short end and for 10 years. It has to be said that so far even that news did not seen USD/JPY boosted: then again, we could argue buy the rumour sell the fact, because we all knew what the BOJ would have to do.

So Japan is doing it. And so is Canada - if we are talking about the central bank being a bulk buyer for public debt; so is Poland; and so are ‘financial stalwarts’ like Indonesia, with its often-wobbly IDR, where a chunk of corona-fighting public spending was just directly monetised in the primary market. That drops the polite pretence that by using the secondary market central banks aren’t actually doing the same thing as bond issuance soars.

However, China’s PBOC once again reiterated Sunday that it won’t be joining the massive liquidity party (although to be fair it got to there first, drank all the good booze, and ate all the dips). Governor Yi Gang used an editorial to stress he expects the economic shock from Covid to be short and the economy to bounce back (though industrial profits were -34.9% y/y in March). He was also concerned that “too aggressive” macro stimulus would lead to inflation and too much leverage in China’s over-leveraged asset-based economy. So, confidence and prudence. Two items in short supply elsewhere.

Is this a reason to go all in on CNY vs USD? On CNY it’s a matter of faith. If you think that China really has beaten Covid-19 and has also beaten its high household, corporate, and public debt, can beat the local demand shortfall and longer needs to rely on export earnings--or the USD--then dive in; if you also believe that China does not have an asset-price valuation problem relative to the rest of the world – then jump; and if you see PBOC prudence will make CNY a store of value as all other currencies inflate their way out - then into the water you go. You might want to check how deep the pool is first, however, to avoid a broken neck. The same goes for AUD by proxy, of course.

Meanwhile, in terms of who’s all in and who isn’t there are lots of other developments worth mentioning:

The Eurosceptic Telegraph’s take on last week’s European post-virus recovery “plan” is, as expected, savage with an Op-Ed titled “Macron Issues Ultimatum to Europe's German Bloc: Cough Up Covid Trillions Or Lose the Single Market”. Certainly, there appears widespread criticism that what we have seen so far is most unlikely to prove sufficient to power a broad-based European recovery once higher public-debt levels and the post-Covid hysteresis effects are considered.

Several newspapers are touting the possibility that countries that recover fastest from Covid-19 might be able to reopen their international borders, with the first suggestions being Australia and New Zealand, in time. This is again something we have previously flagged, not as an opportunity, but as a risk. Which countries are going to get left out of the loop? Most probably the emerging markets being hardest hit by the virus already, who need tourism and export USD earnings the most.

Of course, politics will play a key role in who goes all in with who. Another Op-Ed from a China hawk academic in New Zealand has argued Australian and New Zealand could join hands with Taiwan and smaller Pacific islands to reopen trade and tourism. One does not need much imagination to predict the economic/market fallout if that were to occur. Indeed, China’s ambassador to Australia has today openly warned if the Aussie government presses ahead with a “dangerous” public inquiry into the coronavirus pandemic it could spark a Chinese consumer boycott of beef and wine, tourism and education. Free-trade fans can hopefully here see a display of just how ‘all in’ going all in on trade with another economy can prove.

What can PM Morrison do now? Lose key exports in a very weak economy – or set a key diplomatic precedent and back down, despite cross-party support to continue? Once again is it ‘My way or the Huawei’? (Note Europe has allegedly already done the latter, although this is disputed, in watering down language critical of China’s and Russia’s virus-related actions after pressure from Beijing: Euroskeptics like The Telegraph might say it’s perhaps not surprising that a group whose own members are questioning if they will permanently stay in is not sure who to go ‘all in’ with!)

So what’s the key market message here? Still that political-economy questions of what central banks can and can’t do, and where that does and doesn’t lead us, will set the overall end-point – along with a very large dose of geopolitics in that political economy.

Consider that as we start to see awful Q1 GDP data, key central-bank meetings, and more ‘China vs. XXX’ headlines this week