Submitted by Michael Every of Rabobank
Stranger Things 3 and 4
Want to see something some strange things? Look at the yield curve. This morning in Asia US 30-year Treasuries are at 1.90%, the lowest ever seen; US 10s are 1.47%; US 2s at 1.51% (so, yes, 2s-10s is inverted again); and US 3-month yields are at 1.94%, meaning that the 3M-10Y spread is a staggering -47bp. This is neither healthy nor normal. Indeed, one could argue we are one bad data point away from the US 10-year testing the low of 1.36% last seen in 2016.
30-year Bunds are at -0.19%; 10s are at -0.70%; and 2s are -0.90%. 30-years in Italy are at 2.20%, down 18bp on the previous close; 10s at 1.13%, also down 18bp; and 2s at -0.13%, down 13bp – and that’s as the latest Bloomberg headlines are that “Italian Coalition Talks Stumble, Raising Risk of Early Elections”. Nonetheless, there is a meeting this morning at 08:30 Rome time between the 5-Star anti-establishment movement and the PD deeply-establishment movement, so perhaps that yield movement is justified(?) As noted before, if this is the case then the League’s Salvini can watch from opposition as 5-Star sheds its radical credentials; and with its pro-growth policies watered down by the technocratic PD, he will be well placed to swoop to power when the Italian economy hits what the German IFO survey, and the yield curve, are flagging as serious problems ahead.
In short, current yields scream the failure of the technocratic elite, particularly central banks. Where is the inflation we were promised? Where are the wages healthily driving that inflation on the demand-pull side? That failure is taking us into the surreal world of ‘Stranger Things’, where the US president publicly eviscerates the Federal Reserve at every turn, even calling it an “enemy”.
However, throughout central banks’ persistent failure to achieve their goals at least they could claim they were still scientific and apolitical and ‘not strange’. No longer.
In ‘Stranger Things 2’ last Friday the BOE’s Carney argued for an end to the USD as global reserve currency in favor of something like Facebook’s Libra. That may be technocratic, but it is as (real) political as you can get. Of course, Carney has already been accused of the same thing by Brexiteers. (NB the USD is still going up, not down regardless, even as gold also gains.)
And in ‘Stranger Things 3’ yesterday former Fed member Dudley made a public missive via the Bloomberg opinion page titled “The Fed Shouldn’t Enable Donald Trump”. This argues that ”…trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook. This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along? If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach.
Such a harder line could benefit the Fed and the economy in three ways. First, it would discourage further escalation of the trade war, by increasing the costs to the Trump administration. Second, it would reassert the Fed’s independence by distancing it from the administration’s policies. Third, it would conserve much-needed ammunition, allowing the Fed to avoid further interest-rate cuts at a time when rates are already very low by historical standards…
I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable. Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.”
The implications here are simply staggering. We have a former Fed official lobbying sitting Fed officials to deliberately damage the economy and move away from their stated mandate in order to either force a policy change from an elected president, or to force that president out of office!
I don’t know what ‘Stranger Things 4’ is going to look like, but it will probably have a new cast, meaning a central bank that does more of what the White House wants. Why? Because the alternative is now flagged as the risk of an unelected body deciding not just rates, but trade, economic, and geopolitical/foreign policy over the head of the executive. Surely, real politk says that won’t stand. How can Trump trust any monthly decision of the Fed from now on when they don’t do what he wants on rates? (i.e., cut fast?) Any moderation in the easing cycle will be seen as conspiracy, not complacency. At the very, very least, not cutting into a trade war ensures: (1) a vastly stronger USD, and; (2) a vastly inverted yield curve.
That a former member of the technocratic elite like Dudley could open this can of worms is quite staggering. However, in some respects it shouldn’t be. Susan Strange, the founder of the much-overlooked discipline of International Political Economy, argued that one should never just assume that rules or institutions are neutral and apolitical: anything manmade struggles to be. As an example, since the mid-2000s I have argued that central banks smile at equity inflation, and at house-price inflation, but scream at the risk of wage inflation. Many readers will take this as sensible and “just the way things are”. OK…but it is also a paradigm designed to make the rich richer and working Joes relatively poorer: logically, how can it not be?
Equally, how can central bankers not see this? The answer to that isn’t strange, perhaps: Susan Strange herself might well have quoted Upton Sinclair: “It is difficult to get a man to understand something when his salary depends upon his not understanding it”; and that lack of understanding can be so hard-wired that it becomes genuine, like a divine revelation, rather than just cynical. Recall the ECB media department recently claimed that its QE policy had reduced inequality rather than increased it, with a graphic suggesting the rich were less well-off and the poor better off than before!
Fortunately, even in their current distorted form, we still have markets that allow some independent judgement on what is and isn’t revealed truth. And the truth negative yields reveal is an economic and central banking paradigm that no longer works, and which must change somehow. ‘Dudley-do-right’ may just have accelerated that process.