If I were President Xi Jinping, I’d be confused.
Having been met by anti-communist protestors in Hong Kong last week and now, arriving in Hamburg for the G20 meeting, by anti-capitalist ones he might wonder, why we don’t send all the disgruntled kids from Hong Kong to Europe and ship the European rent-a-mob to Hong Kong and then see how happy they are?
The leaders of the 20 largest economies are coming together to shake hands, take part in some photo opportunities and to then do what? One thing they won’t do is “fix” the world economy. They also won’t achieve much in terms of “fixing” the environment, not least of all as presidents Putin and Trump are scheduled to have their private one-on-one when the a discussion on the environment is scheduled.
This “G” stuff began in 1975 with the G7 or, more precisely, the Group of Six when French President Giscard d’Estaing invited the finance ministers and central bank governors of France, Italy, Germany, Japan, the UK and the US to an informal get together to compare notes and, above all, to work towards more stable currency markets. The West was still in turmoil after the 1973 oil shock and subsequent bout of hyperinflation and a joint approach was considered beneficial. It was in fact not until 1979 and the appointment of Paul Volcker as president of the Federal Reserve that aggressive interest rate policy was used to drive out inflation, a policy fundamentally of his making.
In the post-Bretton Woods world of free-floating currencies, the significant differences in interest rates from one country to another, combined with a deep recession, led to massive forex flows and it was at the level of the G7 – Canada had been added to the group in 1976 – that coordinated action was sought. Stronger emerging economies quite rightly believed that they too should have a voice and, once the G7 had become the G8 by the inclusion of post-Soviet Russia. Then came the G20 so the likes of China, India, Brazil could come for dinner, although by this time the palpable purposes of the original G7 had been lost in the underlying obligation to find common ground among otherwise totally incompatible countries. The G20 has developed into a luncheon and dining club with possibly the worst relationship between expressed intentions and actual actions.
In the end nothing will be left other than a stonking bill for policing and security and happy days for window glass suppliers. That said, and in the words of the late Winston Spencer Churchill, to jaw-jaw is always better than to war-war, such off-grid meetings like the one today between Trump and Putin must have some value. Expect some statements on the environment, on North Korea and the need to fight poverty and social exclusion. All the while Italy’s inevitable push to get India and China to take the odd hundred thousand African migrants won’t add up to too much and I’m not sure whether Malaysia, Saudi Arabia or Turkey will be on the migrants’ wish-list of destinations.
Stocks
Stocks had a bit of a wobbly day yesterday with all major markets other than the Italian MIB index in the red. Rout? Rubbish! The Dow might have lost 158.13 points and the S&P 22.79 points but that translates to a mere 0.74% and 0.94%, respectively. Yes, there was a lot of red on the screens but within the overall context of where markets have come from this is all still a bit of range trading.
Take the Dow. Since March 1 it has traded in a range from just below 20,500 to just above 21,500. Yesterday, after all the harum-scarum, the index closed at 21,320.04, just a tad over 200 points below the index’s all-time high. If any damage was done, it was in the bonds markets but there too the reality is much less dramatic than the overnight hype would have it. US 10-year trading at 2.38% mid. That is all of 3bp above the six–month average yield so again, nothing to see here. The two-year note, however, does have a story to tell as it breaks new ground at 1.41%… or perhaps it doesn’t given that we hit that mark two days ago. The 2s/10s curve now stands at 96.75bp, also below the six-month average of 107bp.
Bonds
In the same way that governments and regulators missed the build-up of risk in the financial system in the run-up to the financial crisis in 2007/2008, so the central banks have been equally blind to risk during quantitative easing and ZIRP. I used to work with a trader, the late Hans Rieckmann, who used to say “Ze money iz not lost, it just belongs to zomebody elze…” The risk, as I recently noted, is also not gone; it too simply belongs to somebody else. A hedge, therefore, does not neutralise risk, it simply passes it on with a fee attached. The leverage behind lending is now largely provided by the central banks and as stimulus is withdrawn by tapering or balance sheet reduction, that leverage has to be provided by the private sector again.
But will that private sector want to gear up when the central authorities are beginning to increase its cost of borrowing? Some researcher or business news scriptwriter on the BBC gave us the line this morning that bond yields are becoming more attractive. Sure Bunds took a bath yesterday and are now at 0.55% but it’s debatable whether losing three points of capital value in a week on a bond with 0.25% annual yield makes a bond market attractive or whether it simply offers a free ticket to catch the proverbial falling knife. I know what mine would be.
My sense is that the Fed will do another 25bp before the end of the year, that the BoE will also have to bring back the 25bp it so frivolously cut in the aftermath of the Brexit referendum but that the ECB will sit pat well into 2018. The problem lies not only with the central banks who have painted themselves into a corner but the surplus of over-educated market analysts and strategists who sit in banks, who have never traded anything other than insults and who are obliged to find something to write about every morning. I have seen routs in my time – how about October 1987, August 1990 or the whole of 2008 – and what’s going on out there at the moment is nothing more than a bit of range trading vitiated by the regulatory authorities’ enforced lack of liquidity and the banking system’s inability to absorb some of the movements. This increases day-to-day volatility but it does not change the underlying fundamentals, which are driven by the rate setters’ instinctive fears of letting too much air out of the asset price bubble too quickly.
Payrolls
Yesterday’s ADP Employment numbers weren’t exactly sparkling but it has to be expected that with unemployment at 4.3% the rate of job creation will be slowing. Analysts’ forecast for today’s nonfarm payrolls is 178,000, close to previous months’ projections of 182k, 190k, 180k, 200k, 180k and 175k. Labour market statisticians are looking a bit like one-trick ponies. Based on James Bullard’s recent utterances and some of the bits revealed in the FOMC minutes, the actual number should be irrelevant as the die is probably already cast.
Alas, it is that time of the week again and all that remains is for me to wish you and yours a happy and peaceful weekend. For many it will not be at all peaceful as school holidays begin along with the prospect of bored-looking children who hate the sun because they can’t see the screens on their phones and tablets. My top tip for the coming weeks is to come out with nothing and to reply to anything they might say with “Yeah, wa’ever”. If they complain it’s too hot, maybe suggest that the coolest place around is probably the village church although when there they might find themselves communicating with somebody very different than their mates from school.