Think! Part 2

Blondemoney enjoys how this blog collates threads because it shows how themes seep through markets (even if it does also show up where she was wrong as well as right). How investors start to come to a realisation of what the driver is. We have had “Hands up if you’re not easing“, “Inflation” and even the esoteric “How volatility eats itself” …. the point is that new drivers turn up which shape how assets are priced: What happens if interest rates are low forever? What happens if inflation is back? What happens when volatility spirals downwards as well as upwards?

But now the theme is an even bigger one.

It has been perplexing to see just how confident everyone became in the narrative that Trump was the new Reagan, but trying to fight it would have led to short-term losses. It has been perplexing to see how Brexit fell off the radar. It has been perplexing to see how Le Pen hasn’t really got onto that radar. What’s been going on?

The market has the wrong rule book. 

It’s no longer about economics. It’s about politics. But the market hasn’t appreciated that yet. Trump fit into the steeper yield cure narrative because the Republican clean sweep was due to deliver a fiscal stimulus. Brexit didn’t matter so much because the UK had delivered better economic data. France similarly isn’t an issue as European PMI data was turning higher.

For each of these, the focus on the politics was purely on how it might affect our standard economic view. Which is shaped by the central bank. To be fair, central banks have been the main actors for 10 years, the only people with the immediate tools to pull us from the abyss. Their mandates determined market moves. The ECB had to do QE to fight its inability to reach its inflation target. The politicians were all sidelined anyway, hamstrung by the markets, who would apparently refuse to fund those countries without sensible fiscal plans. Even when politicians did flare up, such as Tsipras in Greece, it was so that they would play ball with plans to bailout their bond markets.

Markets, markets, markets. We were on top. Primus inter pares. We drove it all. We were the tool to boost animal spirits after Lehman fell. We were the heart of the problem and we were there to solve it. We were Master and Slave of all central bank and political action.

But Blondemoney has to break it to you. We’re not any more. We are no longer driving how economies change; we aren’t dictating how economies must be run; we aren’t being manipulated as the only tool left in a threadbare emergency box. We are not the central hub.

So, now, we have to get used to this.

We are going to be the effect, not the cause, of a whole bunch of policies that are coming down from our political leaders. Currencies to be smashed up in trade wars; interest rates to ebb and flow with a return to normal monetary conditions; stocks to shift depending on tax policies.

If anything, all that buy-the-dip, low-vol from the last few year has just emboldened politicians to forget us. Of course, one day it will come back to bite them, but at this point we have to adjust to the new world order first.

This means understanding that their actions are not rational. Not quantifiable. Not designed just to avoid market mayhem, nor to lever off market positivity. “But the UK can’t agree a trade deal with Trump, it’s not legal!”, “If they do, GBP will get smoked and they’ll have to raise interest rates!”, “the EU won’t let the UK go easily”, “Trump will cut taxes and repeal financial regulation as first priority”, “There won’t really be a trade war because no one wins”……………………….. all of these thoughts might seem terribly sensible. Particularly if you have spent 10 years dealing with the simple equation that “policy makers will always cut interest rates to make things better; they hate volatility”.

Today’s US dollar sell-off is just the start. Trump might want to manipulate the dollar but more likely he just likes to throw it in there as one of his many tools to pick a fight and win the deal. Note, however, that it is his Treasury department that is in charge of dollar policy. He could meddle in currency markets far more than just naming someone a currency manipulator. Who’s to say that one day he doesn’t create a Moscow-Shanghai Accord that sees Russia and China’s central banks uniting against the ECB and the BOE to trash the US Dollar? Who knows – but the point is that the dollar will not then be driven by a rational response to monetary policy. It’s just another policy lever for the ascendant politicians. And who are they beholden too? Well, it’s the people to whom they owe their power.

The voter stood up and told them they wanted change. A change is gonna come.

Hard, Clean, whatever you want to call it, we’re out #Brexit

Surely now, surely, the conversation will move on from “Hard” vs “Soft”. From Supreme Court rulings. From Remainer Hope vs Leaver Disaster. It’s going to happen. The UK is leaving the EU. It therefore has to leave the institutions of the EU, all of them. The single market, the customs union, the ECJ. It then has to re-draw its own relationship with the EU and with the rest of the world. Leaving the single market doesn’t mean failing to achieve single market access; leaving the customs union doesn’t mean failing to trade with anyone in the EU, ever. Leaving the ECJ might be the poison pill in what starts off in any negotiation as the toughest position. “Yes we are off, we are prepared to create new deals, but the body that rules over all of you, won’t rule over all of us in our engagement with you”.

In fact this final point means that the real risk now is not hard/soft/clean/grey….. but orderly vs disorderly. Yes, the exit negotiations can take up to 2 years. But what if the UK just says it’s out, and provokes the EU to stop it? What if the EU says we can negotiate with you, but not if you’re never going to accept the European Court of Justice oversight, so the deal is off? Who sues who in this divorce? And more importantly, who would be the judge that divides up the assets?

Not to mention that we now have Trump telling us that leaving the EU is a “great idea” and that “I believe others will leave”. Oh and that for a UK trade deal, “We’re gonna get something done very quickly”. This is a man who has torn up the rule book already and he’s not even in power yet. He’s called up Taiwan. He’s talking to Russia. He’s not taking questions at press conferences, doesn’t believe his intelligence services, and he won’t be bound by ‘protocol’. Not to mention that he likes deals, and he likes winning. Will he wait 2 years before he can even start talking to the UK about America’s trade deal? Will he wait 2 months?!

And what about the chance of a Le Pen victory in France? If Britain is making progress on a trade deal with the most important nation in the world, is that not grist to her mill of France leaving the EU? OK, you say there’s less than 40% chance she wins… but that’s still a 40% chance that one of the biggest negotiating partners within the EU wants to tear up the allegedly straightforward post-Article 50 exit process itself! Meanwhile Trump wants to slap a 35% tax on BMW if they attempt to export their cars from Mexico. It would be to his benefit if the EU self-immolates over a disorderly Brexit, as he would have even more power over them.

[Of course, we should also recognise that he wouldn’t want the UK getting too strong either, so at some stage he would then threaten to strike a better trade deal with Germany than Britain, for example….]

The point here is that trying to trade this as a simple mathematical equation isn’t going to work. Just today, Blonde Money was told that the leaks over the weekend about May’s speech showed that “immigration > single market access”. As Thatcher would say, No, No, No.

If we really did try to write this as an equation we would end up in the fourth dimension. The market now sits here and waits for what May reveals in her speech. But her speech is not designed for the market. The line that Tory MPs have already been told to take is “The country is coming together”. This suggests that her speech is designed to be Prime Ministerial, re-setting the narrative, and forcing the House of Lords to put up or shut up when they come to pass Article 50. No doubt this is why the speech has been set for a few days before the Supreme Court ruling is expected. This means that if anyone in the market is expecting more details, they must surely be disappointed. This speech is not aimed at us. It’s aimed at reassuring her detractors she has a plan, and at forcing Parliament to do her will. If anything, Cable doing just 2 big figs overnight rather than the 7  of the October flash crash will strengthen her hand. No need to fear a calamitous currency drop – which anyway doesn’t (yet?) seem to be causing any harm, nor indeed does it really bother the government.

More significant therefore could be Carney’s hastily-called speech tonight on “Policy Issues Affecting the Bank of England”. Is this him trying to head off criticism at the pass – now that the declining pound, plus his extra rate cut and QE, are stoking inflation?

Either way, there is now a significant risk premium that needs to be built into GBP… if he was going to take back the rate cut and QE, is that really good for the currency to have such an unreliable boyfriend in charge??

GBP teeters on the edge

Towards the end of last year, Blondemoney attended a conference. The attendees were asked, what’s the big risk you’re worried about next year? 47% said Europe/EU elections; 26% said new US administration. Almost at the very bottom of the list, with just 2% of votes, was Brexit. At the time, that seemed complacent. Now, with Article 50 to be triggered in less than 11 weeks – and in fact with the trigger almost certainly a done deal – it seems downright dangerous to have forgotten about it. After all, GBP managed to shed several big figures in the day of the 7th October flash crash. There’s lots of chatter today about GBP/USD teetering on the edge of 30 year lows around 1.2090 – but then it managed to print below 1.1500 in a heartbeat on no news back then. The BOE are still trying to figure out what happened then…. perhaps by the time they issue the report GBP/USD will have already had a look towards parity! In any case, at some stage this year, with huge chunky and as-yet-misunderstood risks across the spectrum, it looks likely that a new all-time low in GBP is a scenario that needs to be on everyone’s radar.

At the moment, the short-term market is very short of GBP and keen to get shorter. Check out how GBP dipped yesterday on the mere announcement that Theresa May would be holding a speech next week on Brexit. That was good for 50 pts alone when it came out yesterday afternoon:

Cable 13 Jan 2017

Today’s turn higher can be attributed to those short-term guys taking some profits ahead of US holiday on Monday. But overall there is a sense that if GBP were to reach 1.25+ then it would be time to sell it again. Why are people waiting? Because of the worry that there’s no catalyst to plough new lows. The flash crash is written off as “bad liquidity in Asian time“; the better UK data since the Brexit vote is also upsetting the dynamic. Most of the market appear to be Remainers: as soon as the Government lost the first round of the court case that demanded recourse to Parliament before Article 50 is triggered, GBP rallied. There seems to be a desperation to cling onto hope of a ‘soft’ Brexit. As if ‘soft’ means anything at all. We don’t know what Brexit could/would/should look like, so how can we explain which is good/bad for the UK. Markets desperately want this to be a “cut-interest-rates-good / raise-interest-rates-bad” Snowballian kind of story. That makes it easier for them to quantify and understand. Indeed HSBC have even created a “Brexometer” to derive how hard/soft Brexit will be, based on the pound:

hsbc brexometer

oh dear oh dear. So, we take the pound lower if we fear hard Brexit and we can derive probabilities of a hard Brexit from a soft pound?

This is lunacy.

All we need to know is, can GBP go lower right now? Yes.

Will Theresa May tell all next week? No. Her speech is most likely just to ensure she wins the parliamentary and then House of Lords vote on Article 50. Which she will, or there will be riots on the streets.

Sounds like sell the rumour, buy the fact…

Think!

Thus far in 2017, the main questions occupying people’s minds seem to be:

– How many hikes will Fed do, and will BOJ or ECB be the biggest doves?

– How big a fiscal stimulus will Trump and Congress pass?

– How much reflation will the world have?

– Le Pen won’t really win but how much do we still hate the Euro anyway?

– Is China or Turkey or Russia or Mexico going to be the exponentially bad but not contagious EM this year?

Thats absolutely lovely. It really is. They’re good questions. But, my friends, they don’t even scrape the surface of what matters this year. They’re you, of 2 or 3 years ago. They’re flared trousers. They’re pineapples on sticks. They’re at Abigail’s Party. Parochial and unbecoming of a wonderful BM reader like you.

No, as we can see from allegations today that Russia may be able (already has?) enough information to blackmail Trump, these are the questions you need to be thinking of:

– When the trade war starts, who wins and loses?

– When does reflation turn into bad stagflation?

– When will Russia annexe another country and will it start with the Middle East or the Baltics?

– What will Le Pen do when she wins and how will the EU reform itself?

– When will Trump sack half his cabinet and when could he be impeached?

– When will investor exodus from years-long held positions turn into a rout as they realise they don’t know what their risks are and they don’t know how to measure these new risks anyway?

This doesn’t mean these things are going to happen. But it means they’re possible. They’re not zero percent. In some cases they’re even a 50% chance. (Le Pen in particular, given it’s a two horse race).

And the one we can be most certain of is the final question. Forget monetary policy. Forget an EM blow up. Investments are about to blow up, because we have spent decades trying to quantify and master risk: only to find that we are now entering a period where there is no such thing as the unthinkable. No black swans. No distribution of outcomes. No quantifiable probabilities. Just stuff happening. The messy business of humanity.

So today’s Trump report should be the first of many reminders that we have no idea how this Presidency will run. That oil could be $100 or $10, if Putin gained (more?) control of the Middle East. That you need to consider more scenarios than you ever thought possible. You’re going to need to be the most sceptical of your portfolios that you’ve ever been. And ready to think. Fast.

Positioning vs Reality

We are poised to enter one of those potentially confusing periods of Positioning vs Reality. The reality is that yes, the world is in an upswing higher, and was already before the alleged Trump Trades were put on:

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Inflation is back, baby, and you better believe it – with China’s Producer Price Index roaring up to 5 year highs at 5.5%, having been at -5% just 12 months ago….And yes, the rate of change in this inflation in China is the highest it has ever been:

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But then oh dear, what do we have here? Record net shorts on the US 10year:

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And the shortest Yen positions in a couple of years:

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Uh oh. Mind the gap in USD/JPY?