Reality... what a concept

7 min read

Has the world suddenly gone mad or has the world always been mad and is now trying to find a path back to sanity?

The answer is most certainly not be found in the opening line of one market comment I say yesterday evening which read “Risk off day….Treasuries getting crushed….” That is unless, of course, one really does buy into the school of thought that equities are the new bonds and which, until bond yields significantly outstrip dividend yields, they are set to stay. Is the wholesale slaughter of Asian currencies - which sees the Malaysian ringgit making new all-time lows on a daily basis (it’s at M$4.4450 at the time of writing) and which sees the Philippine peso hit Ps50.01 in overnight trade - telling us more about US domestic politics than it is about the state of Asian emerging markets or, again the question, is the world undergoing a fundamental repricing?

Although this might appear to be a huge jump, I go straight to London, or to Westminster to be precise, where Chancellor of the Exchequer Philip Hammond yesterday presented his Autumn Statement. The message was pretty simple and could be summarised as follows: We have no money, we don’t know where we’re going get any from but we’ll increase spending, nevertheless, and hope that in the future something might come along which will bail us out. He didn’t tell us what that something might be but it has to be clear that it can’t be much other than inflation. He can’t say that of course but he is no fool and surely had that in mind.

Next question: did the global financial crisis begin in December 2007 when BNP Paribas pulled the finger out of the dyke or did it begin when the Keynesian concept of counter-cyclical deficit spending was replaced by structural deficit spending without telling anybody that the latter only works as long as the inflation rate is equal to or exceeds the deficit to GDP ratio? In other words, was what we refer to as the global financial crisis nothing more than the last scene of a much longer act? I have no doubt that at some point in the future it will be seen as that but in the here and now that line of argument would be deeply inconvenient. So it is that the UK can blame everything on Brexit and thus justify trying to maintain unaffordably high standards of living and public services by pushing gross debt levels higher than they already are. To then hear commentators in the media suggest that the levels of debt held by Greece, Portugal, Italy and even France are higher, so where’s the problem, makes me spit.

Skint

Hammond opened his speech to the House by confirming that the government will maintain its commitment to fiscal discipline. That’s nice to know although the borrowing forecasts, for what they’re worth, made mincemeat of George Osborne’s plans. Osborne planned net fiscal balances of -£55.5bn (2016), -£38.8bn (2017), -£21.4bn (2018), +£10.4bn (2019) and +£11.0bn (2020). Hammond’s “maintenance of fiscal discipline” revises these figure to -£68.2bn, -£59.0bn, -£46.5bn, -£21.9bn and -£20.7bn, respectively. So whereas Osborne was envisaging a five-year aggregate deficit of £114.6bn, Hammond is looking at £216.3bn which is expected to push the UK’s debt/GDP ratio into the mid-to-high 80s. Miraculously, in five or so years’ time, the ratio is forecast to begin to fall again. Oh really?

I had been under the impression that many citizens who chose to vote to leave the EU did so on the basis that they were prepared to take the economic risk in order to achieve the results in terms of repatriating powers. Now that those risk are being quantified, there is a howling and a wailing and a gnashing of teeth and the chancellor is trying to make a case of having our cake and eating it. Although some of the worst fiscal and economic fears of the Remainers look to be coming true, I do suspect that, were the referendum to be held again today, the outcome would still be very much the same.

I remember the Gilt market being in uproar during the Thatcher years as she privatised state assets and began to pay down national debt. The Gilts guys feared they might run out of paper and ultimately out of a job. No risk of that any longer. 10-year Gilts are now trading at 1.45% which looks pretty shabby in light of the total £126bn of supplementary borrowing that will be required over the next five years. This time last year, before the Brexit referendum had even been announced, we printed 2%. Methinks there is a lot of room for yields to rise and I’d not be in a tearing hurry to rip paper out of the DMO’s hands. At current levels, an increase of yield of around 16bp in the 10-year Gilt would push bonds bought today into negative total return. Is that a risk worth taking, given the grey outlook which Hammond so desperately tried to paint pink?

Meanwhile, and ahead of the Thanksgiving holiday, the minutes of the FOMC’s last meeting were released. There wasn’t much in there that should have surprised anyone but it confirmed, in its own words, that there is a “strengthening case to raise rates soon”. A postponement, it was argued, would increase the risk of sharper monetary action at a later date. What part of 100% certainty can’t the doubters read?

The dollar goes on rising and so do stock markets, or at least US ones. The decline in the value of foreign and export earnings doesn’t seem to particularly worry anybody. It was the late Robin Williams who came to prominence, pre-Mork & Mindy, with his stand-up routine entitled “Reality… what a concept”.

Finally, when the turkey has gone cold and the rest of pumpkin pie is cooling in the trash can, Joe SixPack is scheduled to launch himself on Black Friday, traditionally the biggest day in the calendar for US retailers. The large retailers will open their stores tonight at 6pm while some smart UK retailers like Morrisons have declared this to be Black Week. If only they knew how stupid they sound. I bet they’ll be discounting plastic reindeer next.

I won’t close by wishing Happy Thanksgiving because if you’re American and celebrating the feast you won’t be reading this and if you are reading it, you’re not American and won’t be celebrating. Have a nice Thursday.