Sunday, 22 July 2018

What won't be discussed at Jackson Hole

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Bannon gone and Icahn gone. Two more big names depart the White House team and whether what is left constitutes a team is questionable. That said, Steve Mnuchin and Gary Cohn both now look well entrenched and the sense has to be that John Kelly is beginning to work some magic straightening out the meandering appearance of life in and around the Oval Office.

It’s hard to be “on message” if everybody has their own idea of what the message is and how it is to be conveyed. A more disciplined West Wing can only be good for markets, not least of all as the 200-day track record of the administration is pretty lamentable and investors would be happier if they could renew their confidence in some of the key electoral promises on the economy actually being put into action.

The next two weeks running up to the US Labor Day weekend are probably the quietest in the year, other than the two either side of Christmas. That gives everybody lots of time to speculate what Jackson Hole will bring. Janet Yellen will give an early morning speech on financial stability, which leads me to believe that the symposium will do lots in terms of central bankers patting themselves on the back and little to address some of the storm clouds appearing on the horizon and what the monetary authorities might be planning if they blow in our direction.

I was chatting to a senior official, who shall remain nameless, who bemoaned the staggering arrogance he has encountered when dealing with policy setters at both central bank and law making level. These people, in public at least, seem to believe that they have got the last financial crisis licked and that the global financial ship is steady and prepared to weather all possible storms. So while they are sitting in the warmth of the marine ministry, those who are being sent out to sea – that’s us – are wondering what all the bolstering of the boughs is worth if the boat’s stern has been cut off.

On Friday I received a WhatsApp from a journo who had heard through the grapevine that a major asset manager had decided to close and dissolve one of its corporate bond funds as it feared the asymmetric risk build up between the liquidity it provided its investors as opposed to the liquidity which the Street would be able to afford it, should investors wish to withdraw funds in a significant way.

A growing number of grandees, Alan Greenspan included, have pointed to the corporate bond market as possibly being where risk is most visibly mispriced and where the next big crisis might be looming in the shadows. I remind of Zero Hedge’s observation that Italian high-yield bonds are now yielding less than US Treasuries, which I’m quite sure St Mario won’t mention in his Jackson Hole address.

The asset management firm in question has, so I understand, denied that there is any truth in the rumour. But considering bods with the experience of both my friend from the press and myself treated the story as being perfectly believable this might be an area we should be keeping our eyes on. The GFC began, don’t forget, with BNP Capital Partners admitting that they owned a bucket load of assets, the liquidity and the pricing of which they could no longer live with.

It might be fatuous to put firm numbers on this but if I were trying to read vapour trails, I’d guess that the riskier end of the high-yield bond market has tripled in size since the financial crisis, whereas the liquidity which the Street can provide is at best no more than a fifth.

This weekend I had a friend to stay, an old bond dog like myself in his mid sixties. He runs his brokerage business out of Frankfurt and has done so for over 20 years. Both of us, to be frank, made the best part of our retirement pot during the darkest days of the crisis in 2008 and 2009 and although we small freelance brokers took our pound of flesh for finding liquidity, it was the banks that provided it. The former have largely either been wiped out by regulation or are just about to be by the staggering cost of MiFID II compliance and the latter’s market making capacity has, for lack of a more accurate description, been castrated.

Regulators still haven’t grasped that BMW might only have one globally traded common share but that it has got, through a variety of entities, 131 outstanding bond issues in 13 different currencies and that a seller of the BMW Finance 4.375% 2018 in Oz dollars has got no more in common with a buyer of the BMW US Capital LLC 3.30% 2027 than a plum has with a Boeing 747. The last two, incidentally, share little more than the law of terminal velocity, in case you were wondering.

Since the darkest day of the financial crisis when I made a brief guest appearance at 7IM, I have argued that one of the most fundamental failures of asset pricing is the absence of a realistic valuation of liquidity risk, a function of the door marked “Entrance” always having been much larger that the door marked “Exit”.

The pathological hunt for yield – prompted by ZIRP and NIRP – and the tightening regulatory screw have left the entrance many times larger in the same way as they have left the exit many times smaller. Forget the default value of an AT1 or of a 30-year CCC corporate bond; what is the bid price for my one or two million if Pimco and Blackrock have just been out there sounding the many tens of millions of the same bond which they took down at issue? And then where do all the passives go when they try to sell in order to re-establish index neutrality?

Not only don’t I think that these are subjects which will be raised on the podium at Jackson Hole, I don’t believe they will be raised in private either. Now that the soccer season is with us again, is what I am asking for a new category of Goal of the Month which awards the most elegant own goals too?

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