By Michael Every of Rabobank
Yesterday saw chaos in markets. The 10-year US Treasury yield soared 12bp to 4.80%, the highest since June 2007. We were 4.85% this morning, so up 55bp in a month and 97bp in 2023: another month like that and it will hit a high not seen since 2001. Bonds were of course smashed up and down the curve and all around the world, although many markets missed late US selling, which will no doubt carry over into today’s session. Stocks were, unsurprisingly, lower. FX saw EUR sub 1.05 (to think it was 1.12 this summer!) and JPY hit 150, rally, then fade, as the former ‘Mr Yen’ stated it could go to 155 before the BOJ really act, but if it does and the Fed don’t, it could hit 130 – a 25 big figure trading range(!) Oil rose through the session, though at $91 Brent is well below its recent high.
The editorial of our Monthly Outlook is “Errrrr... for longer”, underlining we are both higher and less certain for longer. Indeed, our Rates Strategy team argues bond metrics (2024 Fed Funds pricing, swap spreads, break-even inflation rates, and term premia - now +22bps after years of being negative) overall say uncertainty is at play. Ironically, can we be certain though when these series don’t go back far enough to show this heuristically? (i.e., they haven’t shown what they do when the inflation regime changes upwards, as in the 70s, rather than downwards, as from the 80s, and they failed to predict the sharp falls of 2008 and 2020.) Indeed, why so much sudden ‘uncertainty, and at what point does it mean you sell and run screaming? Isn’t that called ‘panic’?
Our US Strategist Philip Marey argues a Dynamic Nelson Siegel model of three US scenarios --the FOMC’s macro projections; one of higher inflation, and one of stagnation-- sees the 10-year:
Rising to over 5% in 2024, followed by a gradual decline below 4% in the coming years, while staying stuck over 3% for several more;
Peaking at almost 6.1% in December, then sliding back slowly to about 4.5% - with a projected Fed Funds rate of 7%; or
Falling alongside Fed Funds, ending at 1%.
That’s “quite the bandwidth”. So, uncertainty, yes: and risks to the upside absent stagnation, as US job openings soar above expectations and initial claims remain stubbornly low.
Or, listen to Rick Santelli arguing we could see the 10-year at 13%(!) due to out of control US federal spending (receipts -5% y-o-y despite inflation, spending +50% from pre-Covid), while stressing it would take a collapse in stocks to get markets to run back to bonds and stay there, as in past decades. (The long-run fiscal dynamic is also dreadful in almost every major economy: even in lucky Australia, see here from Ben Picton.) That this view was aired on US market TV is remarkable. Then again, so is so much else around us – and it justifies the ‘uncertainty’ in markets.
In politics, Republican US House Speaker McCarthy was toppled by a Republican putsch led by Rick Santelli fans. Acting Speaker McHenry could be replaced by Majority Leader Scalise, but the pack of wild cards in a political system that already has impeachment and criminal charges swirling around the sitting president and his most likely 2024 challenger continues to build. This should be setting off fire alarms, but some members of Congress are doing that anyway.
In geopolitics, there are allegations Iran has been running high-level influence operations on US and German foreign policy, shocking everyone who doesn’t know anything about the Middle East or geopolitics. Ray Dalio warns China-US relations are 'on the brink of red lines', and US tech restrictions parallel the oil embargo on Japan pre-WW2. The UK admits it has no more spare arms to send to Ukraine. Imagine if (another) war starts, as London considers sending its troops to train Ukrainians there, and Russia says they will be targets if so; the US warns Serbian troops to pull back from the border with Kosovo; and others wonder where Azerbaijan might set its sights next, having seized Nagorno-Karabakh. And India is expelling Canadian diplomats, underlining Justin Trudeau’s status as Canada’s Angela Merkel.
In geoeconomics, the BIS argues global value chains (GVCs) are “in the midst of a far-reaching realignment”, which impacts on the price of everything: and up, not down. Detailed data show supply chains are lengthening across the board, with some onshoring, and the US and China drifting apart. However, there still hasn’t been much real diversification yet, and on the risks of a far-reaching fragmentation of the global trading system, the BIS says the entire system being pulled apart --a 1930’s or Cold War Iron Curtain scenario-- is “highly implausible.” However, it is still “something we will need to watch carefully.” And given the fat tail risks, markets should too.
Especially when the EU released a list of core technologies it intends to protect for itself (from China), including advanced semiconductors; AI; quantum; and biotech; and EVs(!) Even the freest of free traders is embracing industrial policy and mercantilism, as the Financial Times warns ‘China’s electric vehicles threaten to leave Europe in the dust’, drawing comparisons with the collapse of US firms in the 70s when Japanese cars flooded the market. (On which, please see ‘Europe should prepare for a bumpy ride’, which follows work we earlier in the year arguing Europe underestimated its risks of geopolitical deindustrialisation, leading to stagflationary outcomes.) The US, ahead on that protectionist path, is about to tighten its tech controls vs. China even further, as a political storm rises in Taipei (and DC) after Bloomberg reports Taiwanese firms are helping China’s Huawei evade US sanctions.
That’s all inflationary at the margin as well as lifting ‘uncertainty’ - in one direction. Yet the threads between politics, geopolitics, geoeconomics, and markets can run in unexpected directions, creating more chaos. For example, Japan is now talking about using its official foreign exchange special account (i.e., selling US dollar assets) in order to fund a huge increase in defence spending in the years ahead.
However, try to remain Jung at heart in heeding that psychologist when he notes: “In all chaos there is a cosmos, in all disorder a secret order.”
Without delving into secret realms of unity or the “unus mundus” of absolute knowledge, talking about the Eurodollar vs. BRICS commodities as the base of a global collateral pyramid, pondering what the White House might want that’s different from the Fed, or thinking any line on a screen that doesn’t have much long-run history can predict how history unfolds, it’s easy to see why things are so ‘uncertain’ all over:
The global “collective unconscious” is of every economy being angry and/or wanting things to change - and not by going back to the post-2008 New Normal. That’s the kind of experienced synchronicity and “meaningful coincidence” Jung stressed. Call it term premia if you want though.
Indeed, it’s hard to see how the world becomes more ‘certain’ ahead --i.e., low inflation, rates, yields, and high stocks. That’s the case if you think we are higher for longer; or if we are errrr for longer, or even if central banks are going to err for longer, because the resulting socio-political storm that will follow a policy error on that scale will wash many things we take for granted away.
“There is no coming to consciousness without pain,” as Jung also warns. Take that to heart too.