This is not turning out to be a good week for President Donald Trump, not unlike many of the ones that have passed since he was inaugurated in January.
Yesterday, Merck’s Kenneth Frazier, Under Armour’s Kevin Plank and Intel’s Brian Krzanich stepped down from a White House business group set up to advise the president on matters related to business and industry.
The business elite’s frustration with the president’s palpable inability to focus on certain key issues more than fleetingly before being distracted by irrelevances is taking its toll. Yet, behind all the bluster, the shooting from the hip and the midnight tweets, there are some things he has said which should not be dismissed as total rubbish. Who can recall the early days when he branded Germany as a currency manipulator?
I’m not sure how well grounded his knowledge of Europe was – or is – as Germany has no national currency which it might be able to manipulate and although it is the dominant economic force within the 19-member currency union, it is not out there entirely on its own. But the currency manipulation thing, if one is honest, can’t really be made to go away. Then last week Zero Hedge, always good for a view missed by the mainstream, elegantly pointed out that US Treasuries are now yielding more than Italian high-yield bonds.
Wrong
With its blind corporate bond buying programme and its rather ridiculously overcooked zero rate monetary policy stance, the ECB has created what must be a brutally wrong credit risk pricing matrix and, for lack of a better term, risk asset price bubble. The US and the eurozone economies might not be marching quite as hand-in-hand as they had done for most of the past 40 years but they are certainly not as far out of step with each other as the visible discrepancy in monetary policy and in the application of quantitative easing would have to have one believe.
It is no great secret that I’m not all that worried about the immediate future. That is not because I’m comfortable with the ECB’s approach to things but because I believe that it has ridden itself so deeply into the mire of artificial pricing that it can no longer escape without causing total mayhem and there is no way that it will want to go down in history as the central bank which, for lack of a better simile, broke the bank.
St Mario is most certainly no fool and although he always puts on a brave and confident face, that might well be his game face. It is quite possible – personally I pray it’s totally probable - that behind closed doors he wonders what can and should be next if the ECB is to pull itself out of the hole it has dug for itself while not upsetting the apple cart. I’m not sure there’s a proper answer. The Fed is in tightening mode when the ECB is reassuring all and sundry that loose monetary policy will not be reversed until the time is right and yet the euro has appreciated by around 13% against the greenback since the beginning of the year.
Intervention
Europe and the US are both trapped in a low growth, low inflation environment. Both are struggling with excessive public sector debt and both are imbued with an inbuilt inability to realistically address the issue. This column has repeatedly wondered how the Fed intends to implement its much-vaunted balance sheet reduction programme without causing a monstrous imbalance in the capital markets. I was always struck when comments came back along the lines of “It’s not a problem; the Fed won’t sell anything, it’ll just let the bonds run off and that’s it”. Letting bonds run off might work for the lender but the borrower - in the case of the Fed’s holdings it’s largely the US Treasury - the debt still has to be rolled over and new sources of finance will have to be found. The impact on the cost of Treasury debt is unknown but US$3.5trn of additional private sector debt finance doesn’t just pop up out of nowhere.
By intervening in the euro corporate bond market the ECB has created an additional rod for its own back, which the Fed does not have. Don’t worry about the €102bn of corporate bonds that the ECB has purchased; worry about the mark-to-market losses that every corporate bond investor will suffer if, as and when the valve is opened on the corporate bond spread pressure cooker that has been fired up by the bond-buying programme, and super-heated by ZIRP and NIRP.
More to the point, if the euro is bid to buggery under this scenario, where does it go when the euro/dollar interest rate differential begins to close again? The conclusion somehow has to be that both the Fed and the ECB are caught in a roach motel and that they will find themselves forced to lie doggo for a lot longer than the rhetoric would have one believe. The Fed might tighten but it is hard to imagine it being able to extricate itself from the bloated balance sheet within our working lifetimes. On the other side of the pond, the ECB can’t go anywhere near a reversal of monetary policy unless it wants to risk putting millions of workers back on the scrap heap if the currency were to continue to appreciate at the current rate.
Macron
It’s not alone in struggling with avowed intentions and the realities of life. Young Macron, now in the Élysée Palace for 100 days, is experiencing a precipitous fall in his approval ratings. This is after all France, and although everyone agrees that public sector spending is out of control, nobody wants to be the one who might have to concede a benefit for the good of the collective. His attempts to cut the defence budget resulted in the resignation of the chief of staff and the realities of facing the unions over reshaping the social contract still lies ahead.
Macron did not choose to run for the presidency at the age of 39 because he’s a humble and modest man; he breathes with the arrogance of an Enarc and his aloofness is working its way to the surface. We must remember that he is not the result of some great swing away from the established parties; he is the result of Penelopegate without which François Fillon would have swept into the presidency and Macron would have faded away as a footnote in French political history. Thus Macron raced to pass legislation preventing the government-funded Fillon family business thing from being repeated but then he tries to make his wife the First Lady, an office and a concept previously unknown in Europe. France will be France, with or without Macron and although his profile on the international stage cannot be questioned, the real issues at home remain as intractable as they always have been. Methinks a hot autumn awaits in the streets of Paris.
Meanwhile, the Dow closed yesterday within 125 points of its all-time high – so much for the end of the world when it tanked on Thursday – and just 55 points from Wednesday’s close. The media still relate this bungee jump to North Korea. To me it’s no more than a healthy pull-back needed to consolidate some of the recent gains. Risk asset markets remain in good shape and will do so until the likes of the ECB have worked out how to not to pour the baby out with the bath water which, my guess, will not be all that soon. Stay long.