Blain: "Low Rates Won’t Solve The Coming Corporate Debt Crisis"

Blain's Morning Porridge, submitted by Bill Blain of Shard Capital

“Here’s to all the filthy money and where it went..”

So much to think and worry about the morning – the market showing its love and appreciation for BoJo and the heightened chances of a no-deal Brexit by spanking sterling to a 6 month low, or Boeing deciding to rename its troubled B-737 MAX by dropping MAX as Airbus orders come flooding in at the Paris Airshow, but the main story is the Fed.. or should that be how much faith the market is putting in the Fed and the FOMC meeting today/tomorrow? I’m not persuaded…

The market consensus is the Fed will eventually ease US rates, but not this time. It’s how it communicates/hints at timing tomorrow that will be most closely analysed aspect. Expect pages of dot-plot analysis and explanations of whatever he said and meant. Fed-Head Jerome Powell has already made clear the Fed is willing to act to offset slower growth and counter a trade war; “we will act as appropriate to sustain the expansion”.

This is where it starts to look messy. Is it the Fed’s job to “sustain expansion”?

It’s clearly a laudable objective, but let’s not confuse the stock market for the economy! It plays right into Trump’s agenda, his simplistic message to the electorate that stock strength proves his deal making success. An ease would provide a potent hit of short-term ecstasy to an addicted stock market, and give Trump something to crow about - a factor the Liberal press is all over like the proverbial cheap suit. The economy does seem to be signalling recession and problems ahead: an inverted yield curve, the collapse in govt bond yields, and a few negative economic numbers. On the other hand, even Fed Members say the economy is in “a good place”, inflation is not a threat, employment remains high, and trade woes aside… what’s the real issue?

Maybe the Fed should be asking deeper questions of itself? If the Fed were to cut rates.. who benefits and what would change? The stock market will throw a most excellent party and gorge itself higher. But a higher stock market isn’t actually driving the economy – what rising stock markets do in ultralow rate environments is exactly what’ve we’ve seen through years of QE ultra-low rates; returns from the stock market look better than business investment, so borrow money, or convert equity into debt to buy back stocks? More distortion is now what we need.

And low rates won’t solve the coming corporate debt crisis – it will just sustain the number of zombie companies for longer, putting off the reckoning till later, when it will be so much larger. Zombie companies block market niches, kept solvent when economic Darwinism says they should wither and die, opening their market niche to more nimbler new entrants.

What are America’s problems? A rate cut may give a short-term nudge to a lower dollar, but its problem is not the strength or sustainability of the stock market… Apple and Amazon will still be great firms no matter if their stock is up or down 10-20%. The real issues are real economics - like infrastructure and education, although we should also add heathcare and welfare. Without new infrastructure, America economic potential will keep rotting from the centre. Without a stronger, better up-skilled workforce, it’s not going to reap dividends from new tech like 3D, AI and Robotics. Solve these through investment and that will “Sustain The Expansion” through the long-run rather than the short-term high a cheeky rate ease might engender.

You can apply exactly the same logic to the UK… but zero chance of a rate cut here with sterling looking on the ropes.

Back in the UK – and just who is Rory Stewart? Ok – he’s the disruptive insurgent who looks like he was in Stingray. He has the temerity to appeal to Remainers.. Its unlikely he’d win in a 2 way when it comes to the whole Tory membership, but he’s a reminder how fractured the Tories are, and how unlikely a new solution will be. What’s worse for sterling and the UK? A No Deal Brexit exit in Late October, or, on the basis MPs have already voted down such a possibility, and a riven Tory party still unable to get on board? Oh dear.. this doesn’t look likely to get any better..

I was going to rant about Boeing, but I’ll post some stories on the Website. For anyone interested, I’ve posted my first Blain’s Financial Porridge Podcast on the website. This is still very much a Beta-Test, but please give me comments on improving it… It will go properly live as soon as its good enough…