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Wednesday, 17 January 2018

Here we go again

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The new year brings with it the introduction of MiFID II, which in its 1,700,000 paragraphs of rules, will attempt to legislate the introduction of the square wheel and the ruthless punishment of anybody who dares to suggest that it is not the greatest idea since the invention of the round one.

As I suggested late last year, putting 22 referees on a football pitch to individually oversee the actions of every player on either side does not necessarily lead to a better game.

Some things will remain the same as they are every year. We will be told that end-investor demand is strong while in reality positive price action will be the result of banks and dealers rebuilding their inventories. Indeed, most of those “endies” will be busy sorting out year-end reporting issues and trying to work out which side is up with respect to their MiFID II responsibilities.

By mid-month investment dollars will follow and we’ll rally through mid-February when markets discover that they’ve overdone it a bit. We’ll then get a correction, only for prices to pick up again through the end of the quarter. It happens every year and there is no reason for this one to be different.

So far the IT industry alone has benefited – to the tune of US$2bn – from MiFID II and lawmakers who might believe that that cost will not end up being borne by the very people it is supposed to be protecting have another think coming.

MEANWHILE AND DESPITE the above, here is my key scenario for 2018. The promulgated US tax reform package is expected to add US$1.3trn to the annual deficit. This needs to be financed. At the same time, the Fed will continue to reduce its balance sheet. The “cap” is set at initially US$10bn per month which will rise to US$50bn per month, which pans out at US$600bn per year. So the open market has to find nearly US$2trn of extra annual demand in order to absorb the supplementary supply. This alone should push interest rates higher across the curve, resulting in a natural, market-induced tightening of monetary conditions without the Fed having to lead the way through its own monetary policy. The Treasury will be doing its job for it.

Bearing that in mind, the FOMC can remain more accommodative than most of the economists and analysts appear to account for. Thus, I believe, it is quite possible that the FOMC will not, as broadly expected, tighten three times in 2018 but only, at most, twice. It is hard to believe that our central bankers are not as aware as we are that it is they who have created the ongoing asset price bubble and anything they can sensibly do to prevent the thing from blowing up in their faces will surely be done. Having launched the ship, they will be happy not to be seen to have then sunk it again.

ACROSS THE GLOBE economies are performing well and although there is a notable pick-up in inflation – it has risen from nothing to next to nothing – the central banks, from the Fed to the ECB, will try to tighten verbally rather than factually while hoping that a US-led steepening yield curve will do the job on their behalf.

Not having to work too hard at the key interest rate tap will also suit the monetary authorities as it will prevent already over indebted consumers from fleeing the field at the same time as keeping equity markets from panicking and running for cover.

Thus for the coming year risk asset markets don’t look to be under the serious threat that their bubble-like behaviour of 2017 might be expected to augur.

I therefore suggest that this is not the year to cash out of the equity market and also not the year to go chasing bonds.

The oil price now looks well supported; I wrote in October that I could see WTI making US$60 per barrel by year-end. It did just that by closing on Friday at US$60.42, the first time it has broken US$60 since June 24 2015. I don’t want to lean too far out of the window but I suspect we’ll see a US$80 price before we see it back at US$40. That too will have an effect on disposable household income and it will also contribute to doing the monetary authorities’ job for them.

That aside, and reverting to another one of my recurrent themes, the western economic model is built on an assumption that inflation will debase and therefore effectively repay debt and that unless Mr Inflation is allowed to creep back into the room, our entire financial system will continue to hurtle towards a brick wall at high speed.

Fear of the collapse of asset prices and the dire political consequences of a second failure of markets in just 10 years will keep the central banks at bay, monetary policy easier than currently anticipated and markets protected for the next 12 months.

I might of course be entirely wrong although I began 2017 by saying all the wrong things which by and large in the end transpired, against consensus, to be more or less right. I’m hoping for a repeat.

With those thoughts aired, please permit me to wish everybody a successful, profitable and hopefully not overly stressful 2018.

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