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Monday, 23 October 2017

Post Fed, follow the cash trail

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There’s something in the air which makes it feel like the day before Christmas, when the tree is up and decorated and the children are snooping around it, squeezing the parcels and trying to guess what’s in them. My ex-wife, bless her, always used to say (and probably still does) that the best gifts come in the smallest boxes. Thus the members of the FOMC will sit down this morning for the first of the two days of their scheduled meeting.

Then, at 2.00pm EST tomorrow, the parcels will be opened and all hell will break loose, either because they have or because they haven’t announced the first tightening of rates since June 29th 2006. My guess is that there is a decent number of Managing Directors in investment banks’ trading rooms in charge of significant chunks of risk who have never, ever seen a Fed rate rise.

I spent half my career eating and sleeping the US Treasury yield curve which is the litmus paper in the Fed’s monetary policy brew. It, for one, appears to be clueless. The 2yr/10yr went out last night at 148bp. In the past 12 months it has ranged from 131½bp to 177½bp and has averaged 153½bp. I’m sorry, but if any security or metric sits on its own mean ahead of something as important as the end of a 10-year easing cycle, then I, as an observer, can only conclude that the market hasn’t got a clue what to expect will happen next.

I will grant the market that it is coming out of a seven-year hiatus – Lehman Brothers filed for bankruptcy seven years ago yesterday – and that therefore the near-on 300bp 2s/10s curve we had in 2010 ought to be blanked out of long historical charts. In “normal times” a curve of around 100bp would appear to have been steep enough to keep long-end investors happy.

There remains, however, a chilli in the stew which is, of course, inflation. US CPI is currently at 0.2% (July) but this is now being primarily driven by the weakness in the oil price. Ex-food and energy inflation, the core figure, for July was 1.8% and today’s release for August – forge the headline figure – is forecast to show a small rise to 1.9%.

With Funds still at next to zero, real front-end rates are horribly negative. The central banks’ assumption must have been that such negative returns would strongly encourage investment in real assets which has not, to be frank, occurred. Money has instead chased the momentum in financial assets.

The monetary authorities have, by their extremely accommodative policy, created a rod for their own back. Low interest rates and steep yield curves have not really driven growth in investment in the way in which they were intended to and now the question is whether moving in the opposite, counter-intuitive direction will turn the ship around.

Cast your mind back to the “taper tantrum”; the withdrawal of QE by the Fed did not make the oceans boil or bring on a plague of frogs. Likewise, I can’t see the beginning of a tightening cycle spelling the end of the world as we know it.

What it will do, however, is beg the question where the safest place will be to preserve investors’ capital. Sod the ruddy benchmarks and indices and overweight/underweight and quantitative mumbo-jumbo full of gamma and forward vega. Look for dividends and follow the trail of cash. Going into the crisis, we all spoke of return of capital ahead of return on capital. We’re currently not in a crisis and methinks that where there is a transparent return on capital, there will also be a return of capital.

The members of the FOMC are not idiots. They can see that spooking markets is not a good idea but at the same time they will surely not let themselves be spooked by markets either. I think they should go and am certain that if they do, the sun will still rise in the East and hell will not have frozen over on Friday morning. If I’m wrong, can somebody please send me some gloves in exchange for a pair of sunglasses.

Class war

Meanwhile, here in the UK we face the first Prime Minister’s Questions (PMQ) with Dave “You may now call me David again” Cameron on one side and the Jeremysaurus on the other. The latter attended his first official engagement as Leader of the Her Majesty’s Opposition yesterday in the form of a Service of Remembrance on the occasion of the 75th Anniversary of Adlertag, the last grand throw of the dice during the Battle of Britain. During this he either failed to, or refused to, sing God Save the Queen. Do we really have to do all that class war nonsense again?

Is Corbyn the last, we have to wonder, of an old breed of socialists or rather the first of a new one? Greece and Spain tell us that centripetal politics has had its day and that the left/right fronts are hardening again. And in case you missed it, centrifugality has already happened to devastatingly ossifying effect in the United States.

More to the point, the division between rural and urban is growing at a time when the former is being swamped by the more vocal latter’s parochial interests. Would that today change the outcome of the last election here in the UK? Not at all. Whether it might change the next one has to be seen. The first PMQs will tell us something but don’t expect it to be in any way defining.

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