Wednesday, 19 September 2018

On Fed muddles, high hurdles and Deutsche Bank's purges

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Both ahead of and subsequent to the FOMC’s announcement that it would be leaving rates on hold – yeah, yeah, sure – US markets had been up and down like the whore’s proverbials. The Dow, in fact, dropped pretty sharply by around 150 points from 17,710 points before the release to around 17,560 points, only to then rally hard into the close at a whisker under 17,800 points.

What could it have been in the post-meeting statement which firstly had the panic sellers piling out, only to find themselves topped and tailed by a 230 point rebound in the last hour and half of trading?

In the opening lines, the FOMC changed the wording from “Household spending and business fixed investment have been increasing moderately” to “Household spending and business fixed investment have been increasing at solid rates in recent months…” This will have had hawks dancing in the streets as it indicates that the members do not necessarily regard the current rebound as a passing fad.

It goes on and changes “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term” to “The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace…” which assuages the doves.

It then wraps up the changes in the statement by adding the “one size fits all” observation: “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation.”

There we have it. On one hand, the Committee talks about discussing the rate scenario at the December meeting with a view to beginning the tightening cycle, but then on the other it sets an inflation hurdle of 2%, a number which simply miles away from reality. US CPI was last reported for September at 0.0% – that’s “flat” in plain English – and, having bottomed at -0.2% in April and peaked at +0.2% in August, it has averaged the very same 0.0% over the course of the year so far.

Now, the statement doesn’t say that inflation has to be at 2% for tightening to be on the agenda but October CPI, reported on November 17, will have to be well north of 0.2% and trending higher for them to be able to justify a tightening, based on what they have just said. In the event, November CPI is reported on December 15, the day before the December meeting. That will have to again be higher.

In other words, having raised the possibility of a December tightening, the hurdle has been set so high it’s currently out of sight. So equities initially responded with fear and then with their customary dismissive elation.

Bonds, on the other hand, didn’t know what to make of the statement which replaced one uncertainty with another one. The front end of the Treasury curve got slaughtered as 2-year yields moved from 0.63% to 0.70%. That might only be 7bp but it does represent a 10% back-up in rates. Not only that, but at 0.63%, the 2-year note was sitting right on top of its 200 day moving average which has been trending higher in a near perfect linear fashion. Overall, we got a bear flattening of the bond curve, the very opposite reaction to that of equities.

Well done, Madame Yellen! We now know even less about what you and your merry men are really thinking than we did before we started, other than maybe Jeff Lacker of the Richmond Fed who maintained his stance who voted against the consensus and in favour of a 25bp tightening.

Having a Capitol Hill in turmoil is bad enough. Europe is also a political mess but at least the President of the ECB, Saint Mario, offers up a reasonably clear position and one which we know, right or wrong, he will not stray away from. In the USA, though, the FOMC seems to be as fractious as Congress and Yellen seems to be either unwilling or unable to whip her boys into shape. This is not what we would expect of the central bank in the world’s number one economy. As the saying goes “If you don’t know where you’re going, you don’t know when you’re lost.

The homecoming of Deutsche’s chickens 

Meanwhile, the once unassailable and mighty Deutsche Bank is looking decidedly weak at the knees. Through the financial crisis there was a fair amount of “holier than thou” behaviour and neutral observers wondered whether there might be a few skeletons hidden in cupboards which were hidden in other cupboards which were cached in yet even more cupboards. Now some of those chickens are coming home to roost. John Cryan, the still relatively new CEO has begun a process of kitchen sinking and some of what is being thrown in the skip has a fairly rotten odour.

That said, Deutsche surely remains the most powerful bank in Europe and where it goes, others will inevitably follow. Its sharp retrenchment could well let it overtake the fielded in one fell swoop and it would be a brave man who bet against it in the longer term, even if it is a leaner and meaner organisation than the one which currently loves to be seen to be all things to all men. Cryan seems to have decided that it should focus on core values and rebuild itself from the bottom up. The froth at the top of the glass might look pretty but it is the beer underneath which is what one should be focusing on.

Which leaves me with the Chairman of the Supervisory Board, that best-of-breed Austrian Goldman Sachs alumnus, Paul Achleitner. I first came across him decades ago when he was still with the Squid. In terms of self-belief and the ability to make others believe in him, Achleitner has few equals. Without a doubt, he will have us all believe that the aggressive restructuring is part of his long term strategy. Unless I am mistaken, he was appointed Chairman at the same time as Anshu Jain became CEO (or Chairman of the Management Board, in German corporate-speak). That was surely no coincidence, but Achleitner apparently has a top class tailor who makes the finest Teflon suits. He slipped through Allianz’s disastrous acquisition of Dresdner Bank – wanna bet he introduced the deal? – without anything sticking on his reputation. He’s had a good run while avoiding the bullets which would have downed most. If I were a shareholder, I’d be militating for his accepting some of the responsibility – after 3½ years in the chair he can’t still palm off all the blame on his predecessors, can he? – and for his resignation.

I have strong faith that DB will recover, even though the US authorities have identified it as the next provider of Federal deficit financing as they focus on its Russian activities. At €27½, the stock still looks a bit on the rich side, especially with the dividend set aside for the next two years. But if it gets anywhere close to €22.00, I’d be hoovering it up, although I’d avoid the AT1s and other deeply subordinated debt instruments. If you’re going to take the risk, buy something with proper and realisable up-side.

Royal Dutch Shell reported this morning; a sad, sad story but only an idiot would bet against energy in the longer term. Buy the dips - if there are any. Spreads should laugh this off.

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