Panic is not a good look in markets but then neither is complacency and there is little doubt that bond strategists have been living and thinking in a world coloured by Janet Yellen’s reputation as a fully paid-up dove.
On Monday morning 10-year US Treasuries opened at a yield of 1.70%. But by the time the bond markets had looked at the minutes of the last FOMC meeting yesterday, the self-same were trading at 1.88%. That is still a long way off the 2.50% they were at in June last year but it is still a sharp move higher in anybody’s book.
Unemployment at 5%, 2% core inflation and 50bp Fed Funds have never been happy bedfellows. More to the point, the economy rises and falls by how and when “hardworking Americans” spit in their hands and get down to it and not by whether underlying interest rates are 0.5% or 1%. Proof that zirp and its near neighbours have generated significant investment in plant and equipment is harder to find than evidence that trillions of cheap dollars have been raised in the debt markets to fund share buy-backs which, above all, enrich senior executives. When leveraging corporate balance sheets ceases to be a means to an end and becomes an end in itself, the time has come for the monetary authorities to clamp down on it.
So let us briefly assume that June is a done deal. Personally, I still prefer the July meeting for the next tightening move but Madame Yellen must avoid finding herself emulating the Grand Old Duke of York and might now find herself pressed; further prevarication can only further damage the reputation and credibility of the Federal Reserve in terms of being able to lead from the front. Neither of the leading candidates for the presidency of the US seems to be great fans of the nation’s central bank and the FOMC would be well advised to do what it has to do before the end of the year.
I’m not sure whether markets have taken all the political undercurrents on board yet but it now seems as though they have at least ditched the misguided belief that rates are on hold. The next question has to be how risk assets will reprice.
Rising rates should, in theory at least, slow the flow of funds from the debt markets into the equity market as the biggest buyers of shares, namely the listed companies’ own boards, look for better ways to boost the stock price. At the same time corporate defaults should, again in theory, begin to rise as the robustness of business models are tested beyond cheap borrowings.
The new Dell 30-year is still attracting bids having been priced at +575bp and is now more like +550bp/+547bp so it looks as though bond buyers are not yet worried. Credit indices were also largely unchanged in later trading although I would not be surprised to see them trickle wider over the coming weeks. That said, markets are equally capable of taking the line that the economy is strong, that dividends are set to improve and that defaults will become less likely, not least of all in the shale sector which looks a lot less sick with WTI knocking on the US$50-per-barrel door.
As the reins of power in the financial sector are handed over from survivors of the Crash of ’87 to the survivors for Global Financial Crisis of 2008, responses to altered states will surely change and thus we are riding into unknown territory. Of course there are plenty of people out there who are predicting a crash and a financial crisis that will overshadow what happened in 2007/2008 but to me that sounds like generals preparing to re-fight the last war.
A moment on Europe
On the subject of fighting the last war, I heard a fascinating programme on the BBC World Service last night at an hour when I should have been asleep. It looked into the very beginnings of the creation of the Treaty of Rome and the role of Paul Henri Spaak, the Belgian prime minister, in pushing through the negotiations. It also talked of the political DNA of the treaty being downplayed in order not to scare the general populace which, in the aftermath of World War II, would buy economic union but neither political nor military union too.
What struck me was not that political union was a very clear original objective but that the driving forces could never have envisaged that changes in transportation and communication that have changed the world beyond recognition. Many of the objectives don’t need the treaty as they have been fulfilled by changes in global dynamics. They do, however, leave the union struggling when it comes to dealing with other unforeseen changes, such as the disintegration of socio-economic structures in the Middle East and North Africa.
The Sykes-Picot Agreement was 44 years old when the Treaty of Rome was signed and 57 years have since passed. Europe is in need of a fundamental rethink and it would be a shame if the UK had to vote to leave the EU for it to appreciate that single-mindedly pursuing objectives, which were perfectly valid in 1958, without adjustment is dangerous. The migrant crisis of the past few years will not suddenly go away and therefore Europe needs to adapt. At this point in time there are few signs of it either wanting or being able to do so.
Central banks have done all they can and they are now largely running on empty. Politicians are still busy trying to build the dreams of the past. Voters are fed up with being taken for fools. I suspect the British will, one way or the other, vote to remain. I only hope and pray that the idiots in Brussels don’t declare a ‘yes’ vote as a ringing endorsement of the path they are taking and that they take the time for a serious rethink. Oops, did I just see a pink thing with a curly tail fly by?