Over the last few years, we have released several pieces focusing on the US-China bilateral relationship. The purpose of these reports was to provide a framework or roadmap for this critical geopolitical and economic relationship. However, as discussed in the last piece, recent developments have been so utterly transformative that we have decided to create a new publication, the “China Update”. (“US-China: A Pseudo-Cold War”). As the name suggests, this is similar in style to our Japan Update, i.e., designed to keep you abreast of significant developments in this space. But unlike its Japanese peer will only be published on an aperiodic basis. The bottom line is that we want to keep you abreast of events without being overly demanding too much of your time. This “update” is the first of this new series.
A couple of months ago, we flagged our concerns regarding the DAX (“MI2 Trader: DAX Bad Price Action” 19th July). As it turned out, our fears were premature, and we didn’t get any accelerative weakness. The good news is that meant we didn’t add to our initial small short. The bad news is that our concerns haven’t gone away. In fact, they continue to build and not just regarding German stocks (“MI2 Chart Point: Is Risk Running Out of Oomph?” 19th August).
At face value, Friday’s NFP was mana from heaven for the FOMC doves, who want to delay tapering and policy normalisation. As such, it should have been a classic example of Bad = Good, i.e., poor economic data being bullish for risk assets. Yet, perversely, the dollar is up today, commodities are weaker, and equities are nonplussed. That suggests something else is at play, and if we look around, the move in Treasuries has piqued our attention. The jump in yields makes sense at face value, as weak employment growth should allow Powell to keep running it hot and remain behind the curve. However, since the spring, bond yields have fallen steadily and have been utterly impervious to strong and weak data. So why do they suddenly care about one weak NFP, or is something else driving fixed income and if so, what are the implications?
While Powell’s speech on Friday was greeted with predictable jubilation in risk markets, we would like to make a few observations, especially regarding the firebreak he created between rate hikes and tapering. First, this handy piece of forward guidance was undoubtedly intended to prevent a repeat of Yellen’s Taper Tantrum and, in that regard, so far, so good. Unfortunately, equities have overlooked that the balance sheet is also a significant and much more imminent threat to lofty valuations than interest rates. If anything, signalling that you will further delay hikes increases the odds that the Fed will need to taper PDQ to arrest current economic trends (“The Fed’s Balance Sheet: The Definition of Insanity”, 17 August). To that point, if you had any doubts about the importance of QE to stocks, look at yesterday’s price action in European equities after ECB Holzmann’s comment regarding PEPP.
- We started the month, with a video outlining our big picture economic and market views
- As central banks move to normalize policy watch EURGBP and Eurodollars
- The idea that QE and rates are fungible is wrong. Tapering will end in tears again
- We aren’t short risk. But we worry about flagging broad momentum in US equity markets
- Biden has a plan. But US-Chinese relations continue to deteriorate with real consequences
- The continuation of hard-line policies by the Biden Administration surprised China
- The hope is competition and diplomacy will create Chinese compliance and cooperation
- So far, this has failed as the Chinese have pushed back and doubled down on their plans
- This is a pseudo–Cold War with profound implications for markets
While it is too soon to hit the panic button, the last few days have been interesting. In part because, in a rush to explain renewed signs of risk-off, commentators have come out with a myriad of excuses. Everything from renewed concerns around the Delta Variant to China’s clampdown or regulatory risk in the case of Tesla. We have sympathy with all of these. Indeed, on Tuesday, we highlighted our fears regarding the threat posed by tapering (“The Fed’s Balance Sheet: The Definition of Insanity” 17th August). Yet, when we look at the various narratives, none seem to fully encapsulate the market moves, which makes us a little curious. Thus, we are falling back on the old dependable: price action. And when we do, it looks as if risk is running out of oomph!
- We believe that the balance sheet is just too powerful a weapon to be withdrawn
- This is because markets believe QE is reflationary, i.e., it drives higher equities and yields
- Hence, as in the last two tightening cycles, any tightening is ultimately doomed to fail
- Currently, we are less concerned about a dollar Napalm run but worry about equity markets
On Friday, we highlighted a nuanced shift in rhetoric from the BoE and surmised that the “trailblazer economy” trades in the UK might be about to be reinvigorated. Part and parcel of that was a recognition that the post-Covid recovery had been short-circuited by the arrival of the delta variant, which wreaked havoc with the government’s optimism for accelerated re-opening measures.
Over the last few weeks and months, we have designated the UK as the “trailblazer” economy. The rapidly executed vaccination programme gave the UK a head start, especially compared to a dilatory, politicised and incompetent showing from their “European friends and allies”, as Bozza likes to call them. Some of that advantage was temporarily squandered as the delta variant let rip, putting our thesis on hold and allowing European vaccination programmes to catch up to a large extent, although we suspect behavioural factors may still need time to play out in Europe more so than the UK.