Rabobank: "Hey Yellen, It Was Trump Who Was Right, And The Fed Was Forced Into A Humiliating U-Turn"

Submitted by Michael Every of RaboBank

As expected, Monday saw US President Trump help to make China great again – or at least the unloved Chinese stock markets. They saw their highest volume since the heady 1929-ish days of 2015 while soaring 5.6% (Shanghai) and 6% (Chinext), taking both into a technical bull market. So much winning! Of course, sentiment was also helped by the official message being sent out that ‘deleveraging has now achieved its goals’, and that the finance sector is very important to the economy. Deleveraging never even started. Sounds to me like the January flood of Chinese borrowing (worth 5% of GDP) might be more than a one off. It also sounds to me like China is going to try to blow another equity bubble to prop up demand. And that reminds me of an early episode of The Simpsons, one where Lisa has a crush on the bully Nelson, goes to his room and sees a poster saying “Nuke The Whales”, asks “You don’t really believe that, do you?”, and gets the response “I dunno. Gotta nuke somethin’.” Perhaps China is getting its trade-war retaliation in in advance? That might still be useful given Trump has said a signing summit for this deal might happen fairly soon or may not happen at all. So much detail!

Indeed, I would argue that “gotta nuke somethin’”, in its gloriously atavistic imbecility, is actually the financial-market zeitgeist of our age. What else have our central-banks been doing for years and years? Certainly not using their considerable ammunition to help in any way if one takes a long-term view. I say that as Rabo are already predicting a US recession in 2020, which will drag many down with it, and as the OECD now warns that swollen corporate debt piles, which central banks have so encouraged, is of ever lower quality and potentially more dangerous than it was back in 2008. 54% of investment grade bonds are now BBB-rated, up from 30% in 2008. The OECD argues “In the case of a downturn, highly leveraged companies would face difficulties in servicing their debt, which in turn, through higher default rates, may amplify the effects…Any developments in these areas will come at a time when non-financial companies in the next three years will have to pay back or refinance about USD4 trillion worth of corporate bonds. This is close to the total balance sheet of the US Federal Reserve.”

Guess what guys? China is right ahead of you on that curve – which is why it is trying to find another whale to nuke ASAP: things are looking truly ugly given many firms can’t even pay the interest on their debt, let alone the principle. And guess what else? That OECD and China warning sounds like an admission of the Minsky debt dynamic that you might have thought all central banks would have to have learned the lessons of post-GFC. Apparently not, however - because they think they already know everything.

As former Fed Chair Yellen mocked yesterday, Trump doesn’t understand what the Fed’s dual mandates of price stability and stable employment are. That might well be true. But was it the Fed or Trump who publicly called out how dangerous continuous Fed rate hikes are in a debt-laden, Minsky-teetering financial system where the yield curve is still inverted 9bps on 1s-5s even after a pause? I think Yellen will find it was Trump who was right and the Fed who was forced into a humiliating and frankly incongruous policy U-turn. So much expertise! Trump also made a similar intervention over oil prices overnight, and once again they dipped, though are opening up strongly this morning in Asia.

“So much expertise!” is also a nice segway to the UK, where the latest headlines are that Labour might back a second referendum. Let’s just nuke a few recent talking points there:

  1. The Independent Group (TIG) of 11 MPs can only do one of three things: prop up the May government, which it won’t do as it is so anti-Brexit; support a hypothetical Corbyn-led constellation, which it won’t do given 8 of the 11 members quit Labour because of him; or allow the May government to collapse and we get a general election and TIG lose their seats. So no game-changer.
  2. Labour backing a second referendum means nothing. There is no Parliamentary majority for a second referendum because many Labour MPs won’t back it, and the only amendment in Labour’s hand is backing May’s Withdrawal Agreement --the one her own party won’t because of the Irish border issue-- on the proviso it is then put to the people in a final vote!
  3. Delaying Brexit for a few months, which the EU is not united on, just kicks the can down the road. Indeed, one could argue that by delaying to May, for example, the odds of Hard Brexit rise further as at that point any further delay would mean the UK would have to stay in without any EU Parliamentary representation – which clearly cannot work. Nonetheless, GBP is at a four week high as someone/something reads the word “Delay” in a headline and thinks it augers well. Personally, I think the most pertinent headline on Brexit I have seen is: “Stop flushing Yorkshire puddings down the toilet, water company pleads”. We have now changed our house call away from a BOE rate hike in May on that basis (Brexit, not Yorkshire puddings) as Stefan Koopman explains here.

So more easy policy in the UK; ultra-easy policy in China; promises of more easing in Japan; an ECB U-turn to come(?); and the Fed on hold and stopping QT soon at least. And that’s with bullish markets and reasonable global growth – just wait until things head south: if all you have is a nuke, everything looks like a whale.