Scene Of Misery

By Michael Every of Rabobank

Today’s market action is obviously going to be Fed Chair Powell’s first round of semi-annual Congressional testimony. The expectation is that recent US data will have been enough for him to open the door to September as being the magical date when the Fed first cuts rates in this cycle, something market Pavlov’s dogs had first penciled in for this January. Better late than never, as far as markets are concerned, as after that first cut, it’s all (more) gravy, baby. Of course, if Powell doesn’t deliver on that promise, yet again, we can expect some testy money.

While we are waiting for him --and developments in post-election France, which markets decided ‘doesn’t matter much’ with a shoulder-shrugging arrogance any Parisian would be proud of, but ‘Fractured France’ by Erik-Jan Harn shows does-- I want to ponder the bigger picture.

In that light, here’s my mise-en-scène. (Subtitle: “Scene of misery.”)

President Biden has made it even clearer that he won’t be stepping down, regardless of what his own party or big donors in Hollywood or Silicon Valley say. Some press reports he is personally convinced he still has 2024 in the bag, even if the bagmen aren’t. Others say Jill and Hunter Biden, and a coterie of senior advisors, are circling wagons around him.

The Wall Street Journal has an article introducing US Senator Vance, reportedly a strong contender for Trump’s Vice-Presidential slot. Long story short: Vance is an intelligent, eloquent, energetic proponent of a ‘national conservatism’ opposed to Reaganomics and Gordon Gecko-ism; imagine him alongside now neo-Hamiltonian former USTR Lighthizer as Treasury Secretary, and the signal that would send to Wall Street. Yes, Trump would have to win first, and neither appointment might happen if he does, but the potential should be evident that we could see a paradigm shift which markets can’t say ‘doesn’t matter much’.

‘China’s financial elite face pay caps, bonus clawbacks’ “to comply with President Xi Jinping’s “common prosperity” campaign. The nation’s largest financial conglomerates have asked senior staff to forgo deferred bonuses, and in some cases return pay from previous years to comply with a pre-tax cap of 2.9m yuan, according to sources familiar with the matter. Vilified by Beijing as “hedonists” over their lavish lifestyles, top-earning finance workers including investment bankers and fund managers have been among the hardest hit by Xi’s push for a more equal distribution of wealth.” Of course, that pay cap is still vastly higher than any comparable local position, and in the West we also saw action taken on bonuses and higher taxes post-2008; and the French LFI party angling for a role in government are no fans of markets, and in favour of 90% top income tax rates.

‘Chinese bond traders fear ‘dagger to the heart’ as bond yields vanish’. The pay-cap means the plunge in yields this year (the 2-year has fallen from 2.31% to 1.64%, the 10-year from 2.61% to 2.27% and the 30-year from 2.83% to 2.49%) won’t translate into anything extra in the pay packet, while traders wonder how long they will have a job at all if this slide continues, looking at the JGB market as portent. Ironically, the JGB market is roaring back to life as the BOJ tries to normalise rates, and Western bond markets flirted with death by a thousand cuts prior to this latest rate hike cycle. Yet China seems very unlikely to follow that lead given its very high debt levels and evidently slower GDP growth (on the housing/consumer side).

However, even that yield trend has a sting in the tail.

When the PBOC recently stepped into their bond market, the expectation --based on Western experience-- was that they would buy bonds to push yields lower in an attempt to jump-start their low-demand economy, as we did via QE. Yet the PBOC, based on the same Western experience, instead borrowed bonds and sold them at a lower price to try to push yields UP(!) Why? Because the last thing the PBOC is interested in is financial speculation in assets. China is focused on channeling capital into “productive capital”, meaning making things, not into making money from money, which Marx called “fictitious capital”. Yes, they want low rates to encourage productive investment – but only that.

Yet once the Fed starts cutting, there will inevitably be a flood of ‘What if they have to go back to zero?’ speculation, especially if data turn south, and/or, ‘What if they have to do that even if inflation isn’t under control?’ Ignoring the latter, no doubt, Wall Street would not just be salivating but swimming in an Olympic pool of its own drool: Zero rates! Speculation! Financialisation! Leverage! Bonuses! Buy All The Things! And just imagine what this would translate into in assets elsewhere, like Australian house prices: a starter home in Sydney might be, what, A$10m? I’m making that number up: but lots of spruikers would be doing it for real too.

So, let’s join the dots from the above:

Powell might open the door to a September cut today -- which has been our house call for months -- but he almost certainly won’t open the door to pre-Covid ‘new normal’ monetary policy.

After all, even if he cuts on ‘stag’ not ‘flation’, a further step-up in US/Western fictitious capital would be of no use in a world which the need for productive capital of some kinds is going to be underlined by the NATO summit held in Washington, DC – where President Biden is clearly going to try to look his most vigorous. China; and Russia; and Iran; and North Korea are making it abundantly clear what really matters in that regard.

More broadly, France, the UK, and both Biden and Trump, all in very different ways, show the door is opening for significant changes in the Western political economy to recognise this harsh geopolitical reality.

As such, markets’ golden age of ‘elections don’t matter’ is seeing the door slowly closed on it. L’Age d’Or (Subtitle: “Large Door”)

FIN (Subtitle: “Isn’t fine”)