Trying to phone anybody in New York on Monday proved to be an exercise in futility as all but the lowliest jubs who had been sent to switch the lights on and off again had taken the day off.
The US is now six and a bit months into the Trump presidency and there are questions as to whether the economy and the markets are doing okay because of or despite of him, as well as whether they are actually doing that well at all.
The answer, to some extent, is to be found at the front end of the yield curve where the two-year Treasury note is trading at 1.41%, its highest level since shortly after the fall of the house of Lehman in 2008. That said, 10 years ago and just before the whole market edifice began to unravel, the same two-year yielded pretty much bang-on 5%. And now for the critical question, which borrows from Bill Gross: “What is going to be new normal?” We are, after all, still staring at historically very low rates, the benefit of which is now questionable.
Deeper into the valley of debt
For some time I have argued that interest rates that are persistently too low are of themselves disinflationary and that pushing them higher will add more to the popular asset base and hence wealth effect that will erode the position of debtors. That this cannot be done entirely pain free is evident although it would appear that most of the monetary policy of the key central banks in the period since 2007/2008 has been aimed at making sure nobody gets hurt. In doing so, as we all know and hopefully acknowledge, all that has happened is that we have ridden ourselves ever deeper into the valley of debt.
If there is one thing holding back monetary authorities from normalising the interest rate structure, it is fear of social consequences. The extremely long period of low interest rates has lowered the debt service ratio and there are many unanswered questions as to the robustness of debtors, should the costs of debt servicing begin to rise. The US is better protected than most other countries as the mortgage system is built on the 30-year fixed-rate model. Shifts in short-term rates have less impact on net disposable income than they do over here and especially in the UK where the 25-year floating-rate mortgage and more latterly the dominance of the two-year fixed which needs to be refinanced regularly.
But back to the US. We are still a long way from the 3% GDP figure that President Trump envisaged as the key to making America great again. Q1 GDP growth at 1.4% was certainly nothing to be ashamed of but it will not be until we begin to get the figures for Q2 that we will see whether the Trump effect has had any, well, effect. Only the most fervent of supporters of the new Tweetocracy would try to argue that there is already visibly a new spring in America’s step.
The 1.41% two-year might be interesting but the steepening of the yield curve overall with 10s now trading at 2.35% again shouldn’t be overlooked, not least as a bear flattening would have been what most long-term curve-watchers would have been expecting to see. The rates market has a particularly skittish feel to it. The fact is that rates are on the rise and there is nobody out there, myself included, who has any experience of what happens when the cost of borrowing increases in a structurally over-borrowed economy. The most pertinent model we have available is Argentina, which as I said yesterday defaulted three times in 25 years but which can still borrow US$2.75bn of 100-year money at 7.125%.
Meaner than a junkyard dog
Which again brings me back to the monetary authorities. The low rates have pushed investors with long-term commitments into assuming risks that they barely understand while in pursuit of simple income streams. Before Lehman, the high-yield bond market was very much the preserve of specialists. The ratings grades of Ba1/BB+ are still defined by both S&P and Moody’s as being “speculative”. And yet the world and his wife are now long up to the gazoolies in junk bonds. The credit crisis of 2007/2008 was triggered by rates rising and credits falling in a chain reaction rather than in the nice linear fashion that the quant models had used for pricing, and it was of course the banks that were first to take it on the nose.
Distressed debt funds made a killing taking assets off the banks’ hands but one of the largest trades I saw – though I was not involved in, sadly – was Pimco cleaning up the entire MBS book of a Middle East bank, which had simply gone “Eek! Get me out!”. Yes, the banks might be out of the risk game but the vacuum has been filled by real money investors who are now running credit risks that would have had previous generations of portfolio managers shaking in their boots.
But at least for today nobody cares. The whole of th US will be flipping hamburgers and drinking that funny yellow stuff that purports to be beer and is only to be consumed ice cold so that the taste, in as much as it has any, goes away.
Friday brings around the monthly payrolls report but even that, with all due respect, has become a bit like pinning the tail on the donkey. What the Fed does will now depend more on its philosophical approach and to the long-term alignment of monetary policy than on any one release. The FOMC ought to be shocked by the success of the Argentina deal, which tells it a lot of what it doesn’t want to hear, especially with respect to the under-pricing of risk. Higher rates will be needed to stop the rot.
Meanwhile, with the US out, Europe will be flying by instruments alone and it’s probably not a bad day to either go for a long lunch or to spend the afternoon watching Herr Federer begin his pursuit of his eighth Wimbledon crown.